Explaining Agricultural and Agrarian Policies in

Developing Countries

HANS P. BINSWANGER AND KLAUS DEININGER

March 11, 1997

Forthcoming in the Journal of Economic Literature

Table of Contents

1. INTRODUCTION...........................................................................................................................................11.1 UNDERSTANDING THE THEORIES AND MODELS.................................................................................................3

2. THE MAIN PATTERNS OF POLICY, AGRICULTURAL GROWTH AND RURAL POVERTY ......6

3. IMPLICATIONS OF MATERIAL CONDITIONS AND MISSING MARKETS ....................................93.1 MATERIAL CONDITIONS OF AGRICULTURAL PRODUCTION.................................................................................93.2 ADAPTATIONS TO MISSING AND INCOMPLETE MARKETS.................................................................................103.3 IMPLICATIONS FOR THE EVOLUTION OF PROPERTY RIGHTS.............................................................................123.4 EFFICIENCY IMPLICATIONS OF THE INITIAL ASSET DISTRIBUTION....................................................................133.5 ADAPTATIONS TO UNEQUAL LAND OWNERSHIP DISTRIBUTIONS......................................................................15

4. THE IMPACT OF POLICIES ON ACCUMULATION ...........................................................................174.1 SUPPLY RESPONSE AND PRODUCTIVITY GROWTH...........................................................................................174.2 PUBLIC INVESTMENT......................................................................................................................................194.3 CREDIT MARKET IMPERFECTIONS AND ASSET DISTRIBUTION..........................................................................20

5. POLITICAL DECISIONMAKING.............................................................................................................225.1 POLITICAL REGIMES AND DECISIONMAKING PROCESSES.................................................................................225.2 INTEREST GROUP FORMATION........................................................................................................................245.3 CHOICE OF POLICY INSTRUMENTS..................................................................................................................28

6. THE INSTITUTIONAL AND POLITICAL ENVIRONMENT ...............................................................296.1 INSTITUTIONAL ECONOMICS...........................................................................................................................296.2 STATE FORMATION.........................................................................................................................................316.3 CLASS-RELATIONS..........................................................................................................................................37

7. THE ADOPTION OF GROWTH-REDUCING POLICIES.....................................................................407.1 INITIAL CONDITIONS .......................................................................................................................................407.2 LACK OF INSTITUTIONS...................................................................................................................................41

8. POLICY CHANGE.......................................................................................................................................448.1 EXOGENOUS SHOCKS.....................................................................................................................................448.2 REVOLT..........................................................................................................................................................478.3 FACTORS THAT ENHANCE SUSTAINABILITY OF REFORMS................................................................................498.4 FROM TAXATION TO PROTECTION: IS AGRICULTURE A SPECIAL CASE? ...........................................................52

9. MAIN IMPLICATIONS...............................................................................................................................539.1 ELEMENTS AND REGULARITIES WITH EXPLANATORY POWER..........................................................................549.2 POLICY ADVICE WHEN POLICIES, ORGANIZATIONS, AND INSTITUTIONS ARE ENDOGENOUS.............................579.3 TOWARD GREATER PREDICTIVE POWER..........................................................................................................60

10. REFERENCES............................................................................................................................................63

FIGURE

FIGURE 1 THE LANDSCAPE OF THEORIES AND MODELS..........................................................................................4

EXPLAINING AGRICULTURAL AND AGRARIAN

POLICIES IN THE DEVELOPING WORLD

HANS P. BINSWANGER AND KLAUS DEININGER 1

1. INTRODUCTION

The purpose this paper is to describe and, as far as possible, explain variations

in policies, programs, and institutions that influence agricultural growth, agrarian

relations, and rural welfare across developing countries and over time. It also identifies

conditions under which policy reforms meant to bring about greater efficiency and

equity are likely to be initiated and sustained. In section 1, we briefly describe the key

variations in policy, agricultural growth, and rural poverty found across the developing

world. In subsequent sections, we explore the following questions:

• Why focus specifically on agricultural and agrarian policies? We

examine the material conditions and missing markets that characterize the farm

economy in the developing world and show how these influence the agrarian structure

and institutional environment within which agricultural production takes place. We

hypothesize that the special characteristics of the farm economy also influence a

country’s social and political environment, and on the political processes that determine

key policies. If this hypothesis is correct, it provides a strong justification for focusing

specifically on agricultural and agrarian policies.

• How do distorted policy patterns affect the efficiency of agricultural

production and rural poverty? We address this second set of background questions

by summarizing key conclusions from the literature on the agricultural supply response

1 Hans Binswanger is senior policy advisor for agriculture and rural development and Klaus Deininger is aneconomist at the World Bank. We are grateful to Xinshen Diao for important back-ground work on general equilibriummodeling and critical input on early ideas, and to Wendy Ayres for her role as a challenging and effective editor. YairMundlak and Lyn Squire made very helpful comments. This paper is a greatly condensed version of a larger literaturereview from which we had to exclude many valuable contributions and references. The findings, interpretations, andconclusions, are the authors’ own and should not be attributed to the World Bank, its Executive Board of Directors, or anyof its member countries.

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to various policies, and the resulting impact on productivity growth. We also consider

how policy distortions coupled with imperfect and missing markets, and the unequal

distribution of wealth act together to reduce efficiency. With these background

elements we are able to start addressing the key questions explored in the paper.

• What explains the observed differences in policies across countries

and over time? Most of the essay is devoted to investigating this issue. We look

beyond agriculture because political decisionmaking involves players from all sectors.

We review the literature on political decisionmaking, and the literature on the

importance of the institutional and political environment, including approaches based on

analyses of class relations. Finally, we try to understand why so many developing

countries adopted growth-reducing agricultural and agrarian policies, and why the

policies have been so difficult to reform.

• What are the conditions and circumstances under which policy

reforms are likely to be initiated? Under what conditions would policy changes

lead to improvements in efficiency and/or reductions in poverty? And under

what conditions are the reforms likely to be sustained in a new political

equilibrium? We attempt to answer these questions and then examine how the

factors and theories discussed in this essay can help explain why rapidly growing and

industrializing economies, such as those of East Asia, have stopped discriminating

against agriculture, instead giving it a high degree of protection.

• What elements, regularities, and theoretical insights emerging from

the literature reviewed in this essay are most likely to help explain the variations

in policies across countries and over time? How can they be used to improve

policy advice, and policymaking in developing countries? We pursue these two

questions in the concluding section.

• Then, we reflect on the future research agenda and ask how the

elements identified in this literature review can be used to build and test an improved

political economy of agriculture and agrarian relations.

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1.1 Understanding the theories and models.

A bewildering variety of theories, models, and empirical inquiries have been

used to address these questions. We use Figure 1 as a map to locate the various

theories and models, and to structure the essay. The oval in the middle represents a

country. Exogenous influences come from nature or from other countries, and include

shocks (S), technology options (T), ideas (I), and opportunities for trade, borrowing, and

alliances with other countries (F).2

What must be explained are the variables contained in blocks and designated by

capital letters. Policy outcomes (X), which include variables such as the allocation of

rights of different groups, state organizations, and public expenditure patterns, influence

economic outcomes (Q), (such as flows and prices of output). Accumulation alters

material conditions (M)the quantity and composition of the capital stock and the labor

force, the distribution of wealth, and the technology of agricultural production. The

political environment (P), including the nature of the state, the power of interest groups,

or attitudes and ideologies, influences policy outcomes.

Various theories and models, denoted by lower-case Greek letters, explore the

relationships between the variables. The models include static economic models (ε),

accumulation models (α), behavioral theories (β), and political decision models (π).

Models of political economy differ according to the variables (both endogenous and

exogenous) they include and the behavioral assumptions they employ.

2 Each of the symbols represents a multidimensional vector of similar variables. For example, T refers to manytechnologies.

Figure 1 The landscape of theories and models

α Accumulation

modelsΜ

Material conditions

βBehavioral

theories

ΡPolitical Environment

πPolitical decision models

•Investment•Technical change

•Capital and labor force•Distribution of wealth •Technology •Endowments •Population

•Individual•Social•Collective

•Nature of the state•Interest groups•Markets and contracts•Attitudes and ideologies

Foreign possibilitiesTrade, borrowing,alliances

FS

ShocksWeather DisastersExternal shocks

εEconomic Models

QEconomic outcomes

XPolicy outcomes

•Rights•Institutions•Economic policies•Public expenditure

•Flows of inputs and outputs•Prices•Economic efficiency•Distribution of income

TTechnology optionsScience

IIdeas

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Figure 1 can be summarized in the equations below. All variables and parameters

are multidimensional vectors. The endogenous variables appear as dependent variables in

some equations and independent variables in others. In empirical investigations, this

makes it difficult to establish causality. We briefly comment on this problem in the

discussion of the research agenda.

Q = Q ( M, X, F, S | ε ) (1)

∆M = ∆M (Q, X, M, T | α ) (2)

P = P (M, X, I | β ) (3)

∆X = ∆X (X, P, M, Q, F | π ) (4)

Static economic models (ε) relate political outcomes (X) and material conditions (M)

to economic outcomes (Q), such as the composition of production, prices, macroeconomic

conditions, and the distribution of income across factor owners. These models may be

partial or general equilibrium, microeconomic or macroeconomic, optimizing or mechanical.

They generally treat policies as exogenous.

Accumulation models (α) relate economic outcomes (Q) to their long-run impact on

material conditions (M). Some accumulation models examine how investment, factor

mobility, or natural resource exploitation affect material conditions. Others try to explain

how population density, ease of market access, or the capital-labor ratio in an economy is

related to innovation and adoption of new agricultural technology. These models take the

political environment and policy outcomes as exogenous. Accumulation models have been

used extensively to analyze and estimate the economic and social cost of the distortionary

policies described above.

Behavioral theories (β) relate material conditions (M) to the social and political

environment within which political decisions are made. Theories of collective action relate

the ability of interest groups (which are exogenously given) to influence economic

endowments, material conditions, and their access to, and ability to make use of

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information. Analyses of institutional economics, historical materialism, and a large body of

historical literature relate the formation, nature, and behavior of states to material conditions

of production and prior political outcomes. All the behavioral models assume that self-

interest explains the participation of actors in economics or politics, and the specific policy

objectives they pursue.

Models of political decisionmaking (π) relate elements of the political environment, to

specific policy outcomes, and the economic consequences of such policies. They consider

the behavior of political actors (benevolent dictators who maximize a social welfare function,

autocratic self-interested decisionmakers, interest groups) and the nature of voting rules

and mechanisms.

2. THE MAIN PATTERNS OF POLICY , AGRICULTURAL GROWTH AND RURAL

POVERTY

Global agricultural output has grown faster than food demand for more than a

century. Over the same period the proportion of the population deriving a livelihood from

agriculture has declined, real food prices have fallen, and—in many countries—the

proportion of rural households living in poverty has fallen (World Bank 1990 and 1996). But,

there has been great variation among countries and regions in output, productivity, and rural

welfare, with some experiencing large improvements and others experiencing stagnating or

even declining output, productivity, and rural living standards. These variations and their

relationship to government policies and other factors must be explained.

Agricultural policies in developing countries are often highly distorted, as the

literature documents. Krueger, Schiff, and Valdés (1991), in characterizing policy mixes for

eighteen countries from 1960 to 1983, found that:

• Most of the countries imposed high taxes on their agricultural sectors.

• The indirect tax on agriculture from macroeconomic policies, such as overvalued exchange

rates, and measures such as import duties and industrial protection, was three times

the direct tax, such as export taxes, on agriculture.

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• Most of the direct measures were contrary to the country’s long-term comparative

advantage—for example, competitive commodities were taxed, while uncompetitive

(often food) crops were protected.

• Resources provided to agriculture, through measures such as subsidized credit,

infrastructure, research and extension, were not equal to resources extracted.

• The resources that did flow to agriculture almost exclusively benefited large, modern

enterprises, not the many small farmers who, together with landless workers, were

most affected by the net taxation of agriculture.

Still, among the eighteen countries included in the study, performance of the

agricultural sector in terms of growth and poverty reduction varied widely depending on the

country’s agrarian structure, macroeconomic environment, and provision of public goods to

the farming sector. The countries fall into four main groups, depending on their agrarian

structures and the policies they pursued.

First, based on an agrarian structure consisting predominantly of family farms, the

major Southeast Asian countriesIndonesia, Malaysia, and Thailand, following the earlier

lead of Taiwan and Republic of Koreaand China reduced agricultural taxation in the

1970s and started to support smallholders. These countries, in addition to establishing

favorable macroeconomic policies, invested in rural infrastructure and social services,

provided research and extension services, and supported viable smallholder credit systems.

Agricultural output grew rapidly, and the number of rural households living in poverty fell

dramatically. The experience of China illustrates the enormous impact that agrarian and

agricultural policies have on agricultural output and productivity. In 1978 China abandoned

collective agriculture; assigned most agricultural land to families, giving each a very small

holding; and sharply increased the prices paid for agricultural goods. Over the next fifteen

years farm output grew at a rate of more than 6 percent a year. This dramatic increase in

agricultural productivity precipitated China’s long-running economic boom, which continues

today.

A second group of countries, including Argentina, Ghana, Nigeria, Tanzania,

Uganda, Zambia, and many other African countries, also had agrarian structures dominated

by family-farms. However these countries discriminated heavily against agriculture by

8

maintaining overvalued exchange rates, industrial protection, and export taxation. In

addition, they provided little support to agriculture, and the support they did provide went

primarily to relatively inefficient, but politically powerful large producers. Except in regions

with especially favorable agricultural conditions, agricultural output has not kept up with

population growth, and rural poverty has increased sharply. Although many of these

countries have recently initiated macroeconomic stabilization programs and structural

reforms, they are reforming agricultural policies, with some notable exceptions, only slowly.

A third group of countries—including India, Kenya, Mexico, and the Philippines—with

agrarian structures that comprise large estates formed during colonial rule also imposed

heavy taxes on the agricultural sector through unfavorable policies, such as an unsupportive

regulatory environment, dominance of parastatals, exchange rate restrictions, and import

barriers. But these countries also partially compensated for these unfavorable policies by

implementing large public investment programs in rural areas and partial land reform

programs, which addressed structural problems. This combination of policies has resulted

in modest increases in agricultural output and modest reductions in rural poverty. Rent

seeking by large farmers and bureaucrats has, however, often reduced the efficiency of

public spending, which has steadily shifted from investment in public goods (for example,

irrigation) to distortionary subsidies for privately used inputs (for example, water and

electricity), eroding the basis for long-term growth. Reforms of these public expenditure

patterns have begun only recently and are being implemented slowly.

A fourth group of countries—including Brazil, Colombia, Guatemala, and South

Africa—has been characterized by a very unequal distribution of land—with Gini coefficients

that are uniformly higher than 0.8 (often with 2 percent of farmers holding 33 percent of the

land)that dates back to colonial times.3 The unequal distribution of land was worsened by

a policy mix that taxed the agricultural sector directly and indirectly through industrial

protection and overvalued exchange rates. To compensate, rural elites were favored in the

allocation of property rights, public investment, services, credit, and subsidies. Although

governments sometimes made efforts to redistribute land in response to rural unrest and

3 The Gini coefficient measures the degree of inequality in a distribution. A Gini coefficient of zero implies a perfectlyequal distribution whereas a coefficient of 1 implies perfect unequal distribution, with one unit holding everything and all othersholding nothing.

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violence, the programs were poorly designed and consequently achieved little. To the

contrary, because they discouraged tenancy (by restricting property rights or by raising fear

among landowners of future land reform), or explicitly prohibited tenancy, the land reform

programs often led to the evictions of large numbers of tenant farmers, whose loss of

income more often than not outweighed the gains achieved by poor farmers.

Although agricultural output grew rapidly in these countries until the mid-1980s, rural

employment did not grow enough to keep up with population growthbecause by

subsidizing credit, governments encouraged large farmers to purchase farm machinery,

which displaced labor. Agricultural growth largely stopped after governments stopped

subsidizing credit in the mid-1980s with the onset of the fiscal and debt crises. Structural

problems, manifested in widespread rural poverty and rural violence, again demand

attention.

3. IMPLICATIONS OF MATERIAL CONDITIONS AND MISSING MARKETS

It is impossible to consider the consequences of agricultural policies in isolation from

general macroeconomic conditions and policies affecting other sectors. But it makes sense

to investigate the key factors influencing agricultural policies separately, since the material

conditions of agricultural production and the specific imperfections of financial, insurance,

and factor markets in rural areas can explain many observed regularities.4 We first identify

the special characteristics of agricultural production and their consequences. We then

investigate the way policies interact with market imperfections to produce efficiency- and

growth-reducing outcomes. Finally, we explore whether and how material conditions can

help explain policy choices and distortions.

3.1 Material conditions of agricultural production

Agricultural production is characterized by heterogeneity, seasonality, and spatial

dispersion, and by large variations in weather and prices that affect similar producers within

a region in the same way implying that their incomes are covariant. These characteristics

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aggravate the problems caused by well-known informational asymmetries which

characterize contracts for insurance, credit, and labor. Covariance and informational

asymmetries, have major consequences for financial and insurance markets: crops usually

cannot be insured against loss (Hazell, Valdés, and Pomareda 1986), and rural financial

intermediation and credit markets develop slowly and with great difficulty (Binswanger and

Rosenzweig 1986). Spatial dispersion, heterogeneity, and seasonality imply that hired

labor, which does not share in profits, must be closely supervisedand supervision costs

are exceptionally high. 5

These special features of rural areas give rise to three main consequences. First,

many of the institutions in rural areas have developed in response to specific material

conditions and the resulting imperfections in financial, insurance, and labor markets.

Second, fully privatized land rights may not be the most efficient arrangement for rural

economies that are characterized by highly incomplete markets. Third, the way in which

rights to productive assets, especially land, are allocated affects not only the distribution of

income in rural areas, but also the overall efficiency of the rural economy.

3.2 Adaptations to missing and incomplete markets

Missing or incomplete markets can explain many of the characteristics of rural

societies.6 Subsistence orientation, reliance on family labor, and the use of land and cattle

(or other assets) as savings instruments can be explained as the consequence of the

absence, or poor development of markets for products, labor, finance, and risk diffusion

(Binswanger and Rosenzweig 1986, Binswanger and McIntire 1987).

4 This section draws heavily from the large literature on tenancy and sharecropping recently reviewed for the Journal ofEconomic Literature by Otsuka et al. (1992) and the literature on agrarian relations and land markets as reviewed by Binswanger,Deininger and Feder (1995). As the purpose of this section is to set the scene rather than provide a detailed discussion, we referthe interested reader to these references for a more elaborate argument and a borader set of citations.

5 Empirical evidence regarding the supervision costs of agricultural labor can be found in Dong and Dow (1993) and inFrisvold (1994). Imperfections in financial markets, especially if coupled with impediments to the functioning of the land rentalmarket, can counter this advantage and may, in practice, still lead to the appearance of a positive relationship between farm sizeand yields (see, for example, Kevane 1996).

6 Some analysts have argued that peasants do not maximize profits. This controversy over a distinct "peasantrationality" has largely disappeared, and peasant behavior is now modeled as utility-maximizing in settings characterized by highrisk and imperfect markets.

11

Agrarian structure. Many studies of farming systems around the world have shown

that there are few economies of scale in agriculture that might provide advantages to farms

larger than what a family could operate using its own labor (van Zyl, et al. 1995).7 The lack

of economies of scale in agriculture, coupled with the high cost of supervising wage labor,

implies that a farm cultivated by an owner-operator without reliance on permanent outside

labor—the family farm—is the most efficient unit of production. The few exceptions occur

with plantation crops, or where large farms are able to overcome imperfections in other

markets, such as those for outputs, inputs, or credit.8

The degree to which covariate and noncovariate risk can be diversified has important

implications for equity as well as productive efficiency. Where markets are not well-

integrated, prices can vary considerably in response to covariate shocks such as droughts,

leading to distress sales of assets at very low prices. Such sales leave the seller with

insufficient resources to purchase the assets back later when prices return to normal (Cain

1981). These circumstances can lead to the concentration of land holdings even where

large holdings are less efficient than family farms. The inability to insure against the risk of

loss can lead to the use of assets such as draft animals to facilitate consumption smoothing

during periods of crisis (Rosenzweig and Wolpin 1993).

Sharecropping can be viewed as a way to allocate land to efficient family operators

in places with unequally distributed landownership, high environmental risk, and imperfect

credit markets. Although a less efficient system of production than owner operation or

7 The optimal scale of family farms varies widely ammong and within countries, depending on climate and soil fertility,population density, access to markets and infrastrucutre, the opportunity cost of family workers and operators in the urbaneconomy, and the technology available.

8 Many technical economies of scale can be circumvented by rental markets for machines. Other economies of scale inmarketing and credit can be circumvented by village traders, cooperative societies, and contract farming. Managerial economiesof scale can be circumvented by extension services or cooperatives. Thus the worldwide prevalence of the family farm suggeststhat the superior incentives of family members to invest and work hard typically dominate these sources of economies of scale.Exceptions can occur with plantation crops. These are characterized by the occurrence of economies of scale in processing orshipping a highly perishable crop, which leads to a coordination problem between the farm and the plantation. This problem canbe solved either by combining the two operations in a single enterprise, or through contract farming. Thus we see very largefarms producing sugarcane, bananas for export, tea, and palmoil. For all these commodities the share of output from plantationshas declined in recent decades compared with the share from contract farming (Binswanger and Rosenzweig 1986). Anotherexception occurs when there are virtually no markets for inputs, outputs and credit, as has been the case in transition economies.Families are then understandably reluctant to bear the risks of private farming, preferring the safety of producing as part of largeenterprises that can provide some of these services.

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fixed-rent tenancy, sharecropping provides tenants with partial incentives to work hard and

invest, which wage labor contracts do not.9

Social characteristics. Characteristics such as the role of elders in the management

of production and food stocks for large extended families have similarly been explained as

adaptations to high environmental risk, low population density, and the ensuing isolation

from interregional markets (Meillassoux 1981). Spatially diversified social networks, created

and maintained through migration and marriage, help insure against covariate risks and

prevail as long as less costly mechanisms to insure against such risks are unavailable

(Rosenzweig and Stark 1989).

In many cases, however, farmers are forced to resort to second-best strategiesnot

because of the unalterable material characteristics of the productive environment and the

associated market imperfections, but because of government policies. The patron-client

relationship is an instructive example, being considered a relatively beneficial insurance-

substitute in the neoclassical tradition, but as a sophisticated form of exploitation in Marxist

theories (Hayami and Kikuchi 1984; Scott 1976; Bhaduri 1986). Determining which

interpretation is valid requires an examination of the policy and institutional framework within

which these relationships are adopted.10

3.3 Implications for the evolution of property rights

Property rights assign the rights to and rewards from resource use to individuals,

thus providing incentives to invest in resources and use them efficiently (Alchian and

Demsetz 1972). Given the high cost of supervising wage labor, clearly allocating land rights

to owner-operators would generally increase the efficiency of agricultural production.

9 Numerous empirical studies have shown that legal prohibition of sharecropping as "feudal" does not lead to thechoice of fixed-rent tenancy, but rather to further restrictions in small farmers’ access to land (see Binswanger, Deininger, andFeder 1995). Restrictions then lead to further efficiency losses and increased poverty, as in the group of countries with dualisticland ownership patterns. Sadoulet, Fukui, and de Janvry (1994) are unable to find a significant effect of sharecropping,compared with owner-operators, for sharecroppers who are poor, face high risk, or have established long-term relationships withtheir landlords. Shaban (1987), who through the use of panel data adjusts not only for soil quality but also for individual ability,finds that the efficiency loss attributable to share tenancy is modest: about 15 percent.

10 In the United States south the need to maintain a loyal and cheap labor force led large landowners to actively andfiercely resist attempts to replace a paternalistic system, under which they provided some insurance and protection to theiremployees, with systems giving workers access to state-provided benefits such as social security. Not until the invention of thecotton picker, which mechanized the cotton harvest, was social security extended to the south (Alston and Ferrie 1993).

13

However, in environments where information costs are high and markets for finance

and insurance are imperfect, private property rights do not always produce the most

efficient farming arrangements. Abandoning communal land rights for fully tradable

property rights may lead to the loss of safety nets for the poor, the use of economies of

scale in herding, or measures to diversify risk (Jodha 1992; Nugent and Sanchez 1993;

McCloskey 1991). Furthermore, the process of assigning and transferring private property

rights is not cost-free. The costs of maintaining records, negotiating, contracting, and

policing property rights can be high and may exceed the value of the land, especially in rural

areas with low population densities and little market access.

Communal types of land tenure assign to community members clear inheritable

userights to cropland, pastures, forests, and fisheries, and usually allow some degree of

exchange (rental or even sale of land) within the community. They often provide security of

tenure at low cost, and thus do not discourage individuals from investing in the operation

(Migot-Adholla, et al. 1991; Bruce and Migot-Adholla 1994). Since the use of the land and

its output belong to individual cultivators, communal property rights systems rarely lead to

large static efficiency losses—unlike collective farming systems.11 Fully individualized

property rights systems become superior to communal systems only once population

growth and specialization increase the value of land and the efficiency losses associated

with restricting transactions to insiders.

3.4 Efficiency implications of the initial asset distribution

It is well known that in many countries land prices exceed the capitalized value of

farm profits (Binswanger, Deininger and Feder 1995). In periurban areas, where land has

many alternative uses, this is not surprising. Yet the phenomenon is prevalent even far

from cities, because, in addition to the profit stream available from farming, land provides

other services to the owner, which are capitalized into land prices. Where insurance

markets are imperfect (because of the combination of covariance and moral hazard

problems), land provides value as collateral. Land provides additional services, serving as

11 The supervision and monitoring cost advantages of family farms seem to be at the root of the preponderance ofassignments of land to, and production by, individual families. Collective production of crops is very rare, and cropland is almostalways assigned to families on a temporary or permanent basis. Communal use is usually restricted to noncropped forest orpasture areas.

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an inflation hedge, a tax shelter (due to the preferential treatment of agriculture in income

and property tax systems), and collateral to obtain access to subsidized credit (Just and

Miranowski 1989; Brandao and Rezende 1989; van Schalkwyk and van Zyl 1996).

Where land prices exceed the present value of their income streams, poor farmers

cannot buy land, even if they have access to credit at the prevailing interest rate. To pay for

the land with a loan, poor farmers must reduce their consumption below what they can

sustain as workers or sharecroppers. Or, they have to use nonfarm income to service a

part of the debt even in normal years. Thus people need savings or nonfarm income to

acquire land. And this need tends to make the distribution of land holdings more unequal.

Even without macroeconomic instability or policy distortions, rural land markets have

special characteristics. Where nonagricultural opportunities for rural residents are limited,

little land is offered for sale during periods when the weather is normal. Landowners are

made better off by selling land only if they are able to earn a higher return from the sales

proceeds than from cultivation or rental.12 Therefore, rural land sales are likely to be

concentrated in years when profits are low because of adverse weather or low commodity

prices, and take the form of distress sales. Since farmers in the same area are affected by

the same conditions, the sales will often be to moneylenders or other creditors whose

assets are their outstanding loans.13 Thus even without macroeconomic or policy

distortions, land holdings may become concentrated in the hands of moneylenders, large

landowners, people with urban incomes, or others with financial resources.

Does this matter for efficiency? Land rental or sharecropping could equalize the

marginal product of land, labor, and capital in production among land holdings. But these

contracts are second-best adaptations to market imperfectionsand are still less efficient

than owner-operated farms. The initial distribution of land or wealth will thus influence

subsequent allocation of factors of production and has important consequences for the

12 Mortgaged land cannot be used as collateral for working capital. Thus the owner of mortgaged land cannot reap theproduction advantage of ownership, and thus will be unable to repay the loan out of increased income from the land. Onlyunmortgaged land yields a flow of income and other services, the present value of which equals the land price (Feder et al, 1988)Since only unmortgaged land provides these services, land purchases are likely to be financed out of household savings.

13 These financial intermediaries retain the property in their portfolios, sometimes renting it to the very farmers whosold it, until land prices improve with the return of normal weather.

15

long-term productive capacity of the rural economy. Moral hazard, covariance of income,

and collateral value of land imply absent insurance and imperfect credit markets. Markets

for land may therefore fail to bring about Pareto-improving trades and an efficient farm size

distribution—an illustration of the second-best.

The powerful impact of initial land allocations on subsequent agricultural

development can be illustrated by comparing land allocations in the United States West and

in Brazil in the late nineteenth century. In the United States the Homesteading Acts limited

the size of plots that families could acquire to 160 acres. To retain ownership rights,

individuals were required to cultivate the plots for a specified number of years. Owner-

operated farms dominated agricultural production, with rentals and sales merely reallocating

land to more efficient farm families working plots of comparable size. United States

agriculture became one of the most productive systems in the world, and remains so today.

By contrast, in most of Brazil land could be titled only in lots no smaller than four square

kilometers (988 acres)an area much larger than a family could work. Restrictions on

subdivision kept landownership highly concentrated. As a consequence, Brazilian

agriculture became dependent on wage labor and was characterized by relatively low

efficiency and investment. Investment and productivity rose only after government-

sponsored import substitution policies and credit subsidies brought about rapid

capitalization of the sector. Land sales have been unable to reduce significantly the

inequality in the size distribution of holdings.14

3.5 Adaptations to unequal land ownership distributions

Because supervising hired labor is costly, large farms run with hired labor will

generally be less efficient than small farms and will not be able to offer owner-operators

sufficiently attractive contract terms to induce them to give up their own operations. In the

past, where population densities were low, large estates therefore faced severe problems

recruiting workers or tenant-farmers. Policies were often adopted to reduce the profits of

family farms and therefore the reservation utilities of their operators. These policies

14 Not only were financial and insurance markets absent or distorted, during the twentieth century a combination ofmacroeconomic instability, tax preferences for agriculture, and credit subsidies for large farmers drove land prices above thepresent value of farm profits, further reducing the ability of the sales market to bring about an efficient distribution of operationalholdings (Binswanger and Elgin 1988; Brandao and Rezende 1989).

16

included eliminating rights over high quality land; prohibiting the subdivision of large estates;

imposing lump-sum taxes on individuals, huts, and labor; restricting the marketing of output;

and prohibiting the production of lucrative crops (see section 5.2 for further discussion). In

many countries these policies remained in place even after population growth had

eliminated labor shortages. They contributed to inefficiency, stagnation, and rural poverty.

Two predominant types of arrangements arose to reduce the inefficiencies of very

unequal ownership distribution of land. First, in landlord estate systems owners leased their

land to tenants who worked the land with their family’s labor. Most commonly, the

arrangement was sharecropping, a second-best adaptation to the material conditions and

market imperfections of agriculture. Most landlord estate systems have now been

eliminated through land reform programs. Obtaining title to the land they worked provided

former tenants with incentives and resources to invest in physical and human capital,

greater security against exogenous shocks, and often an increased ability to participate in

the political process (Grabowski 1994).

Second, in hacienda systems characteristic of many South American and African

countries, tenants were allocated just enough land to satisfy their subsistence requirements

but were required to work on the owner’s part of the farm, usually to produce crops for the

market. These systems were not only less efficient than landlord estates, but also evolved

less favorably (de Janvry 1981). Land reforms, where they occurred, often resulted in state-

farm or collective-farm structures, which provide very poor incentives for work and

investment, and rarely lead to increases in productivity. In most places, however, the fear

of impending land reform prompted landowners to reduce their dependence on hired or

tenant labor through large-scale evictions. Owners then either mechanized their farm

operations, often with the help of generous government subsidies, or converted their farms

to undertake extensive livestock ranching, which requires very little labor. In many

countries, with so many rural laborers unemployed, wages for all unskilled workers fell,

worsening rural and urban poverty.

In the remainder of the paper we will often refer to the special material and

informational characteristics of agriculture; the difficulties with output, labor, financial, and

insurance markets that they imply, and how they change in the course of development. We

have seen that they are very important influences on the organization of production,

17

peasant behavior, and the interaction among the allocation of property rights, contractual

freedoms, and the efficiency of production. It would not be surprising to observe that these

conditions also affect accumulation processes, such as technical change, and the political

environment within which policies are decided.

4. The impact of policies on accumulation

In order to appreciate the full impact of the policy patterns discussed in the first

section on rural growth and welfare, it is necessary to understand the impact of policies on

accumulation: investment in physical and human capital, the conservation and sustainable

use of natural resources, and the pace and direction of technical change. Accumulation

processes depend on the provision of complementary public goods and infrastructure, and

may therefore be influenced by the quantity and quality of public goods provided to

agriculture and rural areas. The prevalence of market imperfections in rural areas, and the

far-reaching effects these have on incentives and abilities to accumulate will increase the

importance of initial asset distributions in determining agricultural productivity and rural

poverty.

4.1 Supply response and productivity growth

Sustained growth of agricultural productivity is contingent on the generation of new

technologies through research and investment in human and physical capitalfostered by a

policy environment that provides private agents with incentives to engage in these activities.

Policies that discriminate against the agricultural sector will thus have long-term

consequences for agricultural growth and rural poverty, in addition to their static effects.

One reason why it has been easy to adopt policies that discriminate against all or

part of the agricultural sector is that the short-run supply response of aggregate agricultural

output is inelastic, much more so than that of other sectors (Johnston 1960).15 This inelastic

supply response allows myopic politicians to implement agricultural policies without being

fully aware of, or concerned about their ultimate deleterious effects on supply and growth.

15 This is because many of the factors of production are highly sector-specific and therefore not very mobile in the shortrun.

18

While the short-run supply response of agriculture is inelastic, the long-run response

is highly elastic, as the literature unambiguously shows.16 The literature also shows that the

agricultural sector adjusts to changes in the intersectoral terms of trade through individual

investment and migration decisions that have relatively long gestation periods. In the long

term declines in the rate of investment will reduce the rate of change in the implemented

technology used, thus reducing productivity and growth (Mundlak, Cavallo, and Domenech

1989). Policies thus have much larger and far-reaching long-term consequences than

implied in comparative static models.

Boserup (1965) describes in great detail the ways in which population growth has

historically led societies to invest in land improvements and irrigation facilities, to intensify

land use, and to adopt new technologies that resulted in higher sustainable agricultural

production per unit of land. But, not all societies experiencing population growth and

increased market access have shown growth in agricultural productivity, suggesting that

these responses are not automatic. Policies discriminating against agriculture, or parts of

the farm economy, for example, small farmers, are likely to slow the evolution of farming

systems. Take for instance the cases of Kenya and Ethiopia (Heath and Binswanger 1996).

In Kenya (Machakos District), farmers enjoyed secure land rights, access to infrastructure

and markets, fairly favorable terms of trade, and cash income from sales of crops or labor.

A fourfold increase in the rural population over sixty years was more than compensated for

by output growth and investment in land conservation. Ethiopia, on the other hand, lacked

the institutions, policies, and infrastructure favorable to farmer investment. A national

cross-section showed that high population density is associated with soil degradation.

Getting policies right is even more important for agriculture that uses modern

technology, since the growth of total factor productivity can take place in different ways. By

responding to factor scarcities, induced technical change is directed toward products or

16 The inelastic short-run supply response of the agricultural sector is not a result of inherent backwardness orirrationally backward-bending supply curves that would allow the state to extract almost unlimited “vent for surplus” withoutaffecting long-term productivity, as was long believed by Marxist scholars.

19

factors that are most efficient for a particular economy (Hayami and Ruttan 1985).17 If factor

prices are distorted, technical change may not occur or may be inappropriate for the

economy, given its factor ratios. Either would have negative implications for efficiency and

growth.

4.2 Public investment

It has long been known that the potential returns to private investment, and thus its

attractiveness will be affected not only by price policies but also by complementary

investment in public goods, such as education, infrastructure, basic science, and

dissemination of technology. However, despite long-standing empirical evidence that

strongly suggests public investment in these areas generate high returns, the patterns of

public spending observed in many developing countries are not oriented appropriately.

Many countries still neglect primary education, especially in rural areas, and provide

disproportional subsidies to higher education that benefit the better-off (Schultz 1988; van

de Walle and Nead 1995). A large number of studies have consistently found exceptionally

high returns to publicly-funded agricultural research. Despite increases in public

expenditures in developing countries on agricultural research, studies suggest that rates of

return to agricultural research (Evenson and Westphal 1995) and smallholder extension

(Birkhaeuser, Evenson, and Feder 1991) are still well above those for other

investmentssuggesting that countries continue to underinvest.

While skimping on these high-return investments, governments have often spent

large amounts on nonproductive activities with low returns, such as untargeted producer

and consumer subsidies. The literature describing urban bias (Lipton 1977, 1993) provides

qualitative evidence that government investment has often favored the rural elite and the

urban upper and middle classes rather than the small family operator. A number of recent

studies investigating returns to public investment in different sectors demonstrate that public

17 The induced-innovation hypothesis remains controversial, despite the large body of historical evidence that supportsit, especially from agriculture. It is felt that the theory lacks a solid macroeconomic foundation, despite the fact that such afoundation has existed for more than twenty years. In addition, many have argued that it is empirically impossible to distinguishbetween ordinary factor substitution and biases in technical change (Diamond, McFadden, ansd Rodriguez 1978). This is soeven though the problem has been resolved theoretically by Sato (1970) and empirically by Binswanger (1974) for the UnitedStates, using panel data to estimate the underlying substitution parameters and then applying these to aggregate historical data tocompute the factor biases residually. For a recent discussion of the controversy, see Ruttan (forthcoming).

20

investment in many developing countries is focused on sectors, such as state-owned

enterprises and large-scale agriculture, in which state involvement may crowd out private

investment. These investments have not, for the most part, brought about significantly

higher growth, and may even have reduced growth (Easterly and Rebelo 1993; Devarajan,

Swaroop and Zou 1996).

4.3 Credit market imperfections and asset distribution

In the presence of information deficiencies individuals lacking wealth for collateral

may be unable to purchase or lease indivisible assets. They are unable to borrow, not

because they are intrinsically less productive, but because the agency cost (the cost of

supervision and monitoring) of lending to them is prohibitive (Hoff and Lyon 1994).18 These

problems are particularly severe in rural, as compared to urban, areas, where imperfect

insurance markets, spatial dispersion and covariant incomes add to the difficulties of

obtaining access to credit.

The theoretical literature suggests that in the presence of credit market constraints

and indivisible investments, the initial distribution of wealth affects aggregate output and

investment in the short run and the long run. Different initial distributions of assets are

associated with very different, but dynamically stable steady states (Chatterjee 1991;

Tsiddon 1992). Societies in which a relatively equal initial distribution of assets allows a

large number of individuals to make lumpy investments that enhance productivity may reach

permanently higher rates of growth than those in which the highly unequal distribution of

assets prevents such investment. This outcome has several implications that are important

for agrarian relations and rural welfare.

First, if schooling effectively compensates for capital market imperfections, then a

policy of compulsory education could generate high social payoffs, in addition to producing

18 Local lenders can acquire information about the creditworthiness of their borrowers and the risks associated with theprojects undertaken by them at relatively little cost. Their ability to diffuse risk is, however, very limited. Thus the transactioncosts associated with loans for agriculture are high (because of the high reserve ratios required) even in the informal sector, asconfirmed by a large number of empirical studies.

21

immediate gains in productivity.19 A policy requiring schooling could make the distribution

of income more equal and lead to permanently higher economic growth (Eckstein and

Zilcha 1994).

Second, policies that facilitate consumption smoothing in risky environments may

positively affect on productivity by eliminating producers’ need to liquidate their stocks of

productive assets, such as draft animals or land, at distressed-prices (Rosenzweig and

Wolpin 1993; Cain 1981).

Third, allocating public expenditures to urban areas or large farmers who are

politically vocal—practices that have been widely followed in developing countries—does

not help the rural poor gain access to credit. Rather, it undermines their ability to operate

as family farmers, therefore increasing inequality, and also reduces productivity and long-

run growth (Bencivenga and Smith 1991).

Fourth, where rural capital markets are highly imperfect and the distribution of wealth

is unequal, a one-time redistribution of wealth, such as a land reform, may largely eliminate

the need for distortionary redistributive policies later. More importantly, it may also alter the

equilibrium growth path of the economy and lead to permanently higher levels of growth

(Banerjee and Newman 1993; Chatterjee 1991). This outcome is consistent with the land

reform experience in East Asia and suggests that, despite the greater difficulties of carrying

out land reform in the remaining hacienda systems (see section 2.4), doing so would likely

generate considerable social benefits.

Given their impact on accumulation processes, the welfare and equity costs of

distortionary agricultural policies are likely to be very large. Why are such policies adopted?

Why do they persist? Why have so many countries persistently pursued agricultural

policies and expenditure patterns that inhibit efficiency and growth, waste natural resources,

and harm large segments of their populations? And why have the people who are made

worse off with such policies, such as small agricultural producers, rural workers, or

19 One example would be to counteract the market imperfections with a government loan scheme that finances primaryeducation on a voucher basis. The high income elasticity of demand for education and health care, as demonstrated in a numberof recent studies, for example, Squire (1993), suggests that eliminating the constraints that prevent investment in human capitaland providing economic opportunities to use this human capital, may be associated with high payoffs in terms of a moreequitable distribution of wealth.

22

consumers, often been unsuccessful in changing them? To answer these questions, we

must consider the issues related to political decisionmaking and institution formation,

depicted in the left-hand side of Figure 1.

5. Political decisionmaking

We first consider whether differences in political regimes and decisionmaking

processes can explain variations in policy outcomes (equation 4), independently of how

such differences come about. Under ideal conditions a variety of political decision making-

processes can lead to efficiency- and growth-enhancing policy mixes. The fact that many

countries have not experienced sustained growth suggests that these ideal conditions have

rarely been satisfied. It is thus necessary to identify the critical deviations from ideal

conditions, the reasons for such deviations, and their likely impact on policy outcomes.

5.1 Political regimes and decisionmaking processes

Models of political decisionmaking processes have been based on three main

assumptions: a social planner maximizes a social welfare function, an autocratic ruler

maximizes dynastic wealth, or democratic decisionmaking processes make the median

voter decisive. Under ideal conditions all of these systems can be consistent with the

maximization of efficiency and growth (Lal 1993; Olson 1990, Squire 1993).

The three decision rules can also be viewed as special cases of interest-group

equilibria, in which where interest groups use resources to influence policy outcomes.

Competitive lobbying by interest groups can, under certain conditions, lead to the adoption

of policies that raise output and efficiency. This is because such policies produce gains

rather than deadweight costs, so that the groups which benefit have an intrinsic advantage

over those harmed (Becker 1983, 1985).

The first condition holds that politicians act as impartial arbitrators rather than self-

interested players. The state is stable. Interest groups are predetermined and equally able

to use “pressure production technologies” that transform resources (such as labor and

capital) into political influence.

Second, the costs of "influence production" (including the deadweight losses

associated with redistributing resources) are assumed to be convex in the amount of

23

resources redistributed.20 Also, all participants have perfect information, thus being fully

aware of the increasingly distortionary effects of additional redistribution.

Third, an aggregate budget constraint allows decisionmakers to increase public

expenditures only by imposing additional (explicit or implicit) taxes on citizens. The intuition

behind this third condition is straightforward: if all groups have full knowledge of policy

impacts and are equally capable of influencing policies, none will agree to policies that

increases another’s utility without also increasing its own. They will agree only to the

provision of public goods that increase aggregate welfare (for example, infrastructure or

agricultural research).

Although these ideal conditions rarely hold, considering them can still provide

important information on what might happen if certain conditions are not met. For example,

pressure groups with poor pressure production technologies, or few resources to employ

their technologies would clearly be heavily taxed. If acquiring information is costly and

groups can spread misinformation or appeal to ideologies in order to conceal the true

effects of policies, this could lead to the implementation of policies that benefit politically

powerful groups while reducing social output. The presence of self-interested politicians

whose survival in office may depend on the short-term benefits they provide to vocal

constituencies adds further complications. Thus investigating the consequences of political

processes under ideal conditions is unlikely to be useful in explaining the variations in

agricultural policy regimes discussed in section 1.1. Instead we focus on the differences in

political environments within which pressure groups form and interact. First, we look at the

factors which effect interest groups’ abilities to organize politically and use informational

advantages (equation 3). We then turn to the political environment and its implications for

policy outcomes (equation 4).

20 Convexity implies that deadweight losses increase more than proportionately with the amount transferred and thatthe most efficient method of redistribution, that is, the one generating the least amount of resistance, will be chosen. In a numberof important cases this assumption does not hold, although—in the absence of coercion or discrimination—the cost ofredistribution is generally convex.

24

5.2 Interest group formation

If interest groups cannot be taken as exogenously given, we need to pay attention to

the factors that foster their formation (as indicated in the lower left hand quarter of Figure 1).

Interest groups provide members with goods and services that have public-good

characteristics, including information, marketing and other services, and lobbying for

policies or programs favorable to its members. However, the provision of public goods is

associated with a free-rider problem: individuals may enjoy benefits that they do not pay for.

Three main factors help facilitate collective action: ease of communication and

enforcement, clear property rights to economically valuable resources, and members’ high

educational and informational status.

Collective action becomes easier if group sizes are small, benefits concentrated,

communication easy, and enforcement of sanctions possible at low cost (Olson 1971). The

potential for collective action can be enhanced if, in addition to the public good, clubs—

which can range from neighborhood associations to political parties—can provide an

excludable by-product (for example, legal or tax advisory services, or towing for cars) to

members and tie delivery to member contributions. Collective action can also be easier for

groups formed on the basis of identifiable characteristics or social ties, which can create

barriers to entry and enforce rules at low cost.

Owning economically valuable resources can further effective collective action.

Clearly, wealth increases the owner’s ability to spend resources to attain political ends. But

wealth also affects attitudes toward risk taking. If absolute risk aversion declines with

wealth, the poor will be more risk-averse than the rich. Even if they enjoy equal potential for

collective action and equal pressure production technologies, they will invest less in

lobbying for any given reward. The poor will thus be taxed at higher rates than wealthier

agents if tax rates are determined by democratic bargaining between income groups

(Aumann and Kurz 1977).

The risk aversion effect on taxation will be stronger if the poor have higher discount

rates because of imperfect financial and insurance markets, and inferior risk-diversification

options, for example, if they lack nonagricultural sources of income or do not have a strong

social network. That discount rates vary with wealth and income has been confirmed

experimentally for landless workers and farmers in South India (Pender 1992).

25

The educational and informational status of different interest groups affects their

ability to evaluate the impact of any given policy or program on their welfare. With low

levels of education, it is difficult to detect misinformation (in the form of ideology or

“obfuscation”) that may be spread by other interest groups. High levels of education,

informational advantages, and the ability to appeal to popular ideologies, by contrast, can

greatly enhance a group’s ability to appropriate resources for itself.

Clearly observable and distinguishable group characteristics, in addition to furthering

collective action, can facilitate discriminationusing characteristics such as cultural identity,

class, gender, race, or skin-color as proxies for economically relevant traits such as skills.

Historically, discrimination has been used to create and maintain privileges for certain races

and cultures, and to hide the real economic costs of existing privileges.21

The continuing importance of discrimination is confirmed by studies that

demonstrate the existence of systematic wage differentials that are not related to relevant

performance-characteristics, such as schooling or individual ability. Psacharopoulos and

Patrinos (1995), for example, document such differentials for Brazilians of African origin

(who make up much of the poor rural population of the northeast) and for Indian groups in

several Latin American countries (which are over-represented in poor peasant populations).

Observable wage differentials may, of course, be compounded by the fact that certain

groups are denied equal access to economic opportunities, such as education, markets, or

credit, a factor that could—through unequal access to education and its returns—lead to

persistence of such differences across generations. Rural panel data from South India, for

example, show that higher caste status and male gender are associated with better access

to education, even after correcting for schooling of, and inheritance from parents

(Binswanger and Singh 1994).22

21 Roback (1990) illustrates that in many cases racial differences that had fallen into oblivion were resurrected tolegitimize privileges that had no objective justification. Akerlof (1985) shows that sorting on the basis of group characteristicscan be dynamically stable, even if the key characteristics are completely unrelated to individuals’ relevant performanceattributes.

22 In most cases wage equations have been estimated using cross-sectional rather than panel data, and do not thereforecorrect for unobservable individual attributes. The South Indian panel data enabled accounting for both unobservable fixedhousehold effects, as well as correction for parental endowment effects, and therefore represent stronger evidence for thepersistence of discrimination.

26

Finally, since forming interest groups involves costs, the evolution of the social and

institutional environment should involve accumulation processes similar to those discussed

above for physical capital. Theories of social capital formation explore characteristics of the

social and institutional environment formally (Durlauf 1992). They demonstrate that initial

differences in the quantity or quality of social capital, such as trust, affect the ability of group

members to accumulate factors of production and can lead to stratification that is socially

inefficient and very difficult to reverse (Benabou 1994). Conversely, destroying social

capital and traditional institutions, by, for example, forcibly eliminating communal land

tenure as occurred in much of Central America in the 1870s, may have long-term impacts

far beyond eliminating the risk diversification and safety-net functions discussed earlier.

The importance of these factors in interest group formation has been confirmed by a

number of studies (Bates 1983; Magee, Brock, and Young 1989 Swinnen and van der Zee

1994). Gardner (1987) has quantified and evaluated these factors for the United States in

an econometric framework, in order to explore the interaction between collective action,

material conditions, and the general characteristics of the economic environment. Spatial

concentration of production of a specific commodity and lower variability of production (both

of which reduce the cost of communication and organization) lead to greater protection.

Higher output per producer, which would make it easier to form a pressure group with fewer

members, does the same. A high rate of output growth, everything else constant, makes it

more profitable to invest resources in productive rather than redistributive activities, and in

less distortionary policies (observations show that distortionary policies are less likely to be

applied to fast-growing commodities). Regional shifts of production create divergent

interests between "old" and "new" producers, and therefore reduce their ability to lobby for

transfers. Finally, commodities that face import competition receive more protection

because import tariffs or quotas do not require budgetary outlays or taxation of producers;

instead, a large number of consumers bear the costs.

The framework of collective action described above helps identify and define the

groups that would likely form and act collectively to influence agricultural and agrarian

policies. The groups fall into three broad categories: agricultural producers, rural elites, and

urban dwellers.

27

• Agricultural producers are separated by large physical distances, which

makes communication difficult, unless infrastructure—such as roads or telecommunications

systems—is well developed. Furthermore, since agricultural activities are seasonal, the

potential for concentrated collective action is limited to the slow seasons. These limitations

are most pronounced for peasants and other small producers who are widely dispersed,

produce a variety of heterogeneous goods for home consumption and the market, are

lacking education and access to infrastructure, and lack strong social ties. Poor rural

women are less mobile than men, which is important when their interests do not coincide

with those of men, as in the allocation of land rights. To the degree that small farmers are

racially or culturally distinct from dominant groups, discrimination would likely further reduce

their potential for collective action and make them more susceptible to taxation, as

illustrated by a wide range of historical evidence. The differences in income and wealth

generated by discrimination and differential accumulation of social capital in turn reduce the

political action potential of the groups suffering from discrimination.

• Rural elites are able to overcome the disadvantages of spatial dispersion

because they are smaller in number; have greater wealth and education, market

participation, and social integration; and have greater access to modern communications

technology. Their knowledge of agricultural conditions also gives them an informational

advantage relative to urban groups. If they produce a specific (geographically

concentrated) commodity, they may be able to supply and withdraw favors. This enables

them to form clubs that are potentially valuable partners for urban interest groups, even if

the two groups often have different economic interests.

• Urban dwellers benefit from spatial concentration, the relative unimportance

of weather risks, and freedom from seasonal work cycles. Formal urban workers, especially

those who work for large firms or for agencies that deliver public services, can use the

organizational structures of their firms for collective action. They also enjoy steady incomes

that make them less vulnerable to risk. They have a strong economic interest in low food

prices and are able to organize highly visible manifestations of discontent, such as strikes.

Informal urban workers, by contrast, generally have few assets, little education, and small

and unreliable incomes. Yet because they are concentrated spatially, it is still easier for

them to mobilize than it is for peasants. Urban commercial and industrial elites enjoy all the

28

advantages of the rural elites, but without the disadvantages of spatial dispersion and

covariance of risk. Bureaucratic elites share these advantages and may also benefit from

social ties arising from common class origins and educational experiences. Sometimes

they are formally organized into administrative corps, further lowering their cost of

organization. In addition, they have privileged access to information and to the enforcement

mechanisms of the state.

5.3 Choice of policy instruments

The framework under which lobbying can be “socially efficient,” outlined by Becker

(1983, 1985), can also help explain the types of instruments chosen to redistribute

resources in the political arena. First, it is often much easier to transfer resources in the

political arena when the transfer does not involve a visible exchange of money. Thus,

politically, it is easier to transfer resources through distortionary trade, pricing, or tax policies

than through policies involving less distortionary direct payments. That is why it has been

so difficult to decouple income support to farmers and production decisions in industrialized

economies, even though direct income support would enhance overall welfare.23

Second, politically motivated transfers of resources are more acceptable if they can

be administered within existing institutional mechanisms, rather than by creating new ones.

The potential to use existing organizational structures or organizational residues to

redistribute resources is particularly great in the agricultural sector. Numerous institutions

of supply management and price stabilization (marketing boards or buffer stocks) that had

been established during times of war or commodity price collapses, with the goal of

ensuring food security or supporting producer prices, have subsequently been converted

into agencies whose primary purpose shifted increasingly toward transferring resources to

powerful lobbies (Krueger 1992).

23 A shift to overt support for farmers through transfer payments that are financed from the regular budget, rather thanthrough price policies financed by all consumers, may be resisted because it would be less regressive, falling more on higher-income earners who are more vocal politically.

29

Third, appealing to popular ideologies enhances the political feasibility of

redistributive measures.24 For example, in many countries redistributive measures have

been justified to attain food security, agricultural modernization, environmental protection, or

economies of scale in agricultural production. Yet innumerable studies show that few

policies meant to promote food security actually benefit poor or hungry households.

Conversely, the use of ideologies enabled socialist governments to establish state farms or

collectives, and enabled many capitalist governments to direct scarce resources toward

supporting large haciendas, despite considerable theoretical and empirical evidence

demonstrating the efficiency advantage of family farms.25

6. THE INSTITUTIONAL AND POLITICAL ENVIRONMENT

In this section we discuss how the insights from the previous sections can help us to

understand the evolution of the institutional and political environment, (equation 3) and its

impact on political outcomes (equation 4). We discuss institutional economics and the

historical literature before shifting the discussion to recent class-based approaches.

6.1 Institutional economics

Institutional economics is concerned with why institutions vary so much across space

and why they change over time. Institutional economics sees the state as a rational device

created to reduce the transaction costs that arose once economic relations became too

complex to be handled within personalized networks of exchange (North 1989, 1990).26

Transaction costs include costs of measuring the attributes of goods or services, specifying

24 It is not clear to what extent ideas and ideologies are used to bring about political and policy changes, rather than tomerely legitimize policies that would have been adopted anyway because of interest group pressure. Nor is it clear to what extentideas and ideologies facilitate the spread of specific policy mixes across countries. The literature on agricultural policies andagrarian relations does not address these issues. Further research is needed.

25 The substantial empirical evidence assembled by Chayanov, shows that the high productive capacity of peasantagriculture had no impact on the policy of collectivization of the Soviet Union in the late 1920s, but was instead suppressed(Thorner, Kerblay, and Smith 1966). Similarly, the considerable evidence indicating the negative association between farm sizeand productivity generated during the 1960s and early 1970s (Binswanger, Deininger, and Feder 1995) had no influence on theagrarian strategies that were adopted in many Latin American and or southern African countries.

26 In economies characterized by personalized exchange relationships, trust-based "contractual technologies" rely on adense communication network, common ideologies, and a set of rules to which all adhere. The personalized networks aresufficient to maintain the optimal level of economic activity. However, with increased volumes of exchange, personalizednetworks become less efficient means for economic activity and trade.

30

the nature of exchange between parties (the contracting technology), and enforcing

contracts. The state reduces transaction costs by providing public goods, such as

impersonal rules of exchange and institutions that enforce laws.

North points out that under certain material, political, and economic conditions, which

form transaction cost constraints, states are not established, even though this would be

economically beneficial. Instead inefficient institutions are adopted. These conditions

include barriers to collective action within a given social organization, high fixed costs and

risks of establishing or transforming institutions, and networks that provide disincentives for

individuals or groups to adopt new rules of the game unless most others do the same, and

(d) preferences that are based on ideologies.

Competitive constraints, which arise when economically powerful groups from inside

or outside the state are able to contest and challenge the ruler’s legitimacy and monopoly

on power, may also lead to the establishment of suboptimal institutions.27 While competitive

constraints may limit the potential for rulers to arbitrarily exploit their subjects, they may also

give rise to anarchy and chaos, a weak state characterized by stagnation and poverty, and

the dissipation of resources rather than investment.

In North’s framework institutional change is closely related to changes in relative

prices or in ideologies that alter the political bargaining power of different groups.28

Changes in real prices occur because of exogenous changes in material conditions, such as

changes in population density, productive or military technology, or trade. The relative

bargaining power of different groups shifts with exogenous changes by enabling groups to

win higher payoffs through recontracting, or by challenging the fairness of existing

contractual arrangements. Thus changes in prices and material conditions directly affect

political outcomes.

27 The concept of competitive constraints is closely related to that of contestable monopoly (Baumol, et al. 1982).

28 Ideology is defined as the willingness of individuals to pay for their convictions. The relation to the relevanteconomic variables, that is, the ability to pay, is not drawn. This definition ignores the fact that ideological convictions matterlittle as long as they are not accompanied by the (economic) power to enforce them. Even the abolition of slavery, oftenattributed to a shift in ideology, occurred only when the power to enforce the new law became available.

31

The historical material discussed in the next section explores these ideas in much

greater depth, and examines the role of material conditions, and the impact of changes in

material conditions on the political power of interest groups and class alliances.

6.2 State formation

A well-functioning and stable state in which all interest groups are represented and

can interact freely must exist before efficiency-enhancing policies can emerge. How do

such states arise? What influences their characteristics (lower left hand quadrant in Figure

1)? In this section, we explore how material conditions strongly influence state and

institutional characteristics. To understand the political economy of rural areas it is

essential to go beyond agriculture.

Like other institutions, states are formed because they are useful to specific groups

of economic agents. To focus on the relationship between material conditions and the

nature of states, it is useful to adopt a broad comparative perspective, as in Tilly (1990).

Tilly defines states as organizations that control the principal means of coercion and armed

forces in a population that enables them to attack external and internal rivals in order to

promote the states’ (or the ruling groups’) interests, requisition needed resources from

subjects, and ensure a minimum acceptable supply of food, means of production, and

economic well-being for the people.

In this framework an issue of critical importance is whether states acquire the

resources necessary to function through extractive or through representative institutions.

Extractive institutions rely on coercion, yield relatively little revenue, and, most importantly,

do not encourage private investmentand thus do not instigate a virtuous cycle of growth

and increased provision of public goods. Such virtuous cycles arise only where

representative institutions, such as parliaments and courts that limit the power of leaders to

arbitrarily change rules or expropriate resources, have been established. Then, strong

32

institutions, such as secure property rights and impartial enforcement of contracts,

encourage investment by private individuals and facilitate sustainable growth.29

What are the conditions that facilitate the formation of representative rather than

extractive institutions? One recurring theme in the historical literature is that representative

institutions were more likely to arise when a reasonably well-defined and stable government

was faced with fiscal crisis. To meet the associated resource requirements, ruling groups

often had little choice but to agree, through bargaining, to the establishment of

representative institutions in exchange for resources (Tilly 1990).30 Throughout history, this

has been the main reason representative institutions were created. A second issue of great

historical relevance is that, once established, institutions, ideologies, or organizational

structures often acquired a life of their own and remained in place even after the groups that

had created them or the material conditions that led to their formation had disappeared or

changed. Such organizational residues continued to affect economic behavior and

allocation of public resources.31

While bargaining between interest groups is the decisive mode of interaction when a

state exists, material conditions and factor endowments determine the range of feasible

production and military technologies, thus limiting the degree of specialization that is

possible and the nature of the state that can emerge. Three main categories can be

distinguished: domestic, capital-intensive, and coercion-intensive societies.

29 Historically, representative institutions became important as changes in technology made war increasingly capital-intensive which necessitated the establishment of costly standing armies. Even in centralized states, such as France or Prussia,which had managed to limit the power of representative institutions for several centuries, representative institutions acquiredmore power with respect to the crown as regular taxation, credit, and payment of the national debt became essential for themaintenance of the armed forces.

30 A formal description of such bargaining and the set of possible solutions is presented in Hong (1987) and Skaperdas(1992).

31 An important type of such residues are institutions that had been established to cope with fiscal or food supply crisesduring times of war. Instead of being dissolved after the war, they acquired new functions. In the industrial and developingworld the origins of a number of state institutions for managing food supplies can be traced back to the great depression andWorld War II. In developing countries marketing boards and state-owned marketing organizations for key commodities such assugar, and a large number of food parastatals fall in the same category. The changing purpose of such institutionsfrom pricestabilization, to financing of the war effort, and finally the continued taxation of small producersis well-documented (forexample, Helleiner 1966, Krueger 1992).

33

• Domestic societies. These are based on villages and social structures that

operate without or on the margins of states and are characterized by smooth and

uninterrupted, but slow transitions to more productive forms of agriculture and secure

individual property rights in land (Boserup 1965). Societies undergoing this sort of

transformation were limited to isolated areas with low agricultural or mining potential, and

relatively low population densities. Examples include Argentina until the nineteenth century,

Colombia, Iceland, and Papua New Guinea—regions that were relatively isolated, with too

few resources to interest foreign powers—and Jos Plateau in Nigeria or the central cantons

of Switzerland, territories that were easy to defend. In all these regions low population

densities, a lack of goods for export, and consequently little economic specialization led to

the creation of very small political entities with little formal administrative structures and

relatively egalitarian societies that remained largely outside broader economic or political

systems.32

• Coercive societies. Coercive societies are characterized by low economic

specialization, low investment, and highly coercive political structures, led by either an

external power or domestic ruling class or nobility. Coercive societies arose where

population densities were low, land was abundant, and populations were spatially

dispersedand where a state was able to impose itself on local populations. Their

formation can be explained as follows (Tilly 1990).

First, since specialization was limited and land was abundant, collecting taxes

required coercion. Thus much tax revenue was dissipated on military action rather than

spent on public goods or invested in productive enterprises.

Second, the spatial dispersion of the population meant that a central ruler had to rely

on intermediaries to collect taxes. The tax collectors maintained independent armies,

acquired considerable power, established sizable fiefdoms. and often amassed substantial

wealthat the expense of the central ruler who was reduced to heading of a loose

32 There are two main types of domestic societies. Meillassoux (1981) shows that where climatic risk is low, such as inthe subhumid and humid tropics, societies are relatively unstratified, composed of loosely connected family-clans. However,where covariate environmental risks are high, societies have hierarchical social structures dominated by elders. In arid and semi-arid environments the survival of households depends on grain storage, a task best entrusted to elders, who have experienceevaluating the risks and consequences of failing to manage stores carefully and who possess the social status to enforce decisions.Binswanger and McIntire (1987) have further extended this analysis.

34

federation. A central ruler had to strengthen his position by increasing competition for or

monopolizing access to the elite, or through central enforcement of a legal code—an option

that was available only where loyal enforcing institutions, such as a bureaucratic corps or

the military, existed.33

Third, in areas with low population densities that produced goods primarily for export

(minerals or agricultural outputs) rather than for domestic consumption, it was often very

difficult to recruit laborers. Since land was abundant, the native population had little reason

to work in the mines or the large farms unless they could earn more than they could on their

own farms. Four solutions were used to solve the problem of labor shortages: attractive

incentives were offered for immigration (Prussia, United States); slaves were imported on a

large scale (Brazil, the Caribbean); indentured laborers were brought in from labor-abundant

countries such as India, China, and Ireland (United States, the Caribbean, Fiji); or the

reservation utilities of independent peasant producers were reduced through taxation and

discriminatory interventions in factor and product markets (Kenya, South Africa, Peru).

While the first action was not directly coercive, the other threewhich involved

measures such as taxation, limitations on economic opportunities, restrictions on spatial or

occupational mobility, or overt discrimination—depended on strong coercive power.

Regardless of their form and primary purpose, the economically most important and lasting

effect of these measures was their impact on the ability and incentives to accumulate

physical and human capital. They severely reduced efficiency and productivity growth, and

in many cases left institutional legacies and organizational residues that outlasted the

groups that had created them or the material conditions (such as low population density)

that originally led to their introduction. 34

33 In Russia the central ruler strengthened his position by enforcing legislation to stop individual landlords from raidingeach other's labor forces. He endorsed laws requiring the return of escaped laborers to the original owners, actions that would notnormally be taken by the producers. Given the prevailing labor shortage, it would have been more profitable for them to employ theescaped workers themselves.

34 Community institutions often remained the foci of popular life and potential bases for resistance against the powerelite, as long as there were no alternative representative institutions through which the elite could be held accountable. In bothEngland and France the importance of community institutions declined once households were able to appeal to independentnational courts to define and enforce their property rights, suggesting that the development of accountable and predictable rulesgoverning the exercise of elite power are necessary, though not always sufficient conditions for the transformation of community-based institutions (Magagna 1991).

35

For example, it has been argued that the Indian caste system originated to reduce

the potential for peasants to establish their own farms on unsettled land where land was

abundant. The discriminatory institutional structure that developed remained even after

population densities had increased, raising the scarcity value of land and making it possible

to collect land taxes without coercion. The caste system, along with the continued

extraction of a large proportion of farm output from the peasantry, resulted in severe

agricultural stagnation: yields in most of Indian agriculture in 1970 were little different from

those of 2000 years earlier (Lal 1988).

There are many examples of coercive institutions which arose in colonies where land

was abundant, for example in Nigeria in the nineteenth century or Brazil, Prussia, Russia,

and South Africa much earlier. To maintain control over widely dispersed populations,

central rulers "co-opted landlords and clergy, subordinated the peasantry, built extensive

bureaucracies, and stifled their bourgeoisie" (Tilly 1990). Not surprisingly, these colonies

were characterized by low levels of private investment, relatively high levels of resource

dissipated in internal power struggles, and a large role for the state and the military.

• Capital-intensive societies. These societies are characterized by high levels

of private investment and the existence of representative institutions, which often emerged

through lengthy bargaining between groups of comparatively equal power. Examples

include city-states, such as Venice or the Low Countries, which initially prospered from

cheap transport by sea and relatively high population densities (Tilly 1990). These societies

obtained the bulk of their revenues from taxes on trade and achieved a relatively high

degree of independence from agriculture and landlord interests. Furthermore, the relatively

low cost of communication, the organization of subjects into trading organizations (guilds),

and international competition between different trading centers made it difficult for the rulers

to extract taxes and made investment in public goods more desirable. Establishing

representative institutions was by no means a smooth process, generally involving lengthy

bargaining between rulers and subjects.35 As the state became increasingly dependent on

35 For example, in Genoa most of the population was initially excluded from the benefits of trade and economicdevelopment, leading to political instability, civil wars, and low growth. Exogenous shocks in the form of repeated foreignaggression triggered policy reforms that established a representative form of government and, through the separation oflegislative and executive power, brought about greater security of property rights. This change led to a spurt of technological andorganizational innovations, and rapid increases in trade volume that soon made the city a major economic power (Greif 1994).

36

revenues from individual entrepreneurs making decentralized investment decisions in

increasingly integrated financial markets, it became perilous for rulers to adopt obviously

growth-reducing policies.

The bargaining power of subjects and the establishment of representative institutions

advanced greatly where a state’s financial crisis required an immediate solution. The much-

quoted case of the United Kingdom shows how this occurred (North 1989; Tilly 1990). For

centuries neither the king, the merchant elite, nor the landlords were able to establish a

clear supremacy of power. Through the concentration of commercial activity in a single

location, London, the commercial elite established a strong power base. Because

population was low-density and high dispersed throughout the rest of the country, the king

depended on powerful intermediaries to collect taxes and maintain law and order. Given

these conditions, fiscal crises that brought the monarchy close to bankruptcy forced the king

to concede political and legal rights to the landlords and merchant elites in return for their

support, leading to the establishment of independent institutions.36 Once a parliament had

been established that represented the political views of the three interest groups, the king

lost his power to control redistribution, and thus his power to adopt growth-reducing

extractive policies. Still, while the bargaining between politically vocal groups prevented

adoption of the most obviously efficiency-reducing forms of taxation, the new system did

have a negative impact on nonelites. The peasantry lacked political representation, paid the

bulk of the taxes, and lost most of their land rights in the process.

The more recent literature on policy reform supports the general view that reform

attempts are most likely to be initiated and succeed when the state is facing fiscal crisis,

and that efficiency-enhancing policies will be sustained only when groups that benefit from

the policies defend them against pressure from groups that benefit from the alternatives.

Becker’s model, emphasizing the importance of equal access to “lobbying technology” by

contenders as a precondition for constrained-efficient outcomes, is the counterpart of this

set of historical findings.

36 In Spain, by contrast, where the colonies offered the possibility of almost unlimited resource extraction throughrepression and physical force, there was no pressure to prevent the emergence of an extremely wasteful apparatus of unproductivebureaucrats, which eventually reduced economic growth directly and indirectly.

37

6.3 Class-relations

Some of the most complete and insightful descriptions of the patterns found above

are discussed in a large literature inspired by historical materialism. Within this framework

of analysis, self-interested classesdefined as groups of individuals who, given their

ownership of productive factors such as land, labor, and capital, behave in economically

similar waysare the main political and economic actors. The material determinants that

govern relations of production, surplus appropriation, and the interests and power of classes

are described in detail, and the state is viewed as an instrument that serves the economic

interests of the dominant classes or ruling elites. Political decisionmaking mechanisms are

used or altered by the dominant classes to further their economic interests. Ideology is not

an independent factor but a policy tool.37

The most elaborate and original application of a Marxist framework to explain

relations of production in agriculture at the periphery of the industrial world has been

provided by de Janvry (1981). He shows how in Latin America class alliances led to the

establishment of dualistic structures characterized by a concentration of industrial

production on luxury goods and dependence on imports for other goods, such as capital

and basic consumption goods. In this situation of economic disarticulation “development”

was equated with minimizing labor costs, leading to regressive and repressive labor

policies, and proletarization of labor.

De Janvry (1981) shows how these patterns of development led to stagnation,

impoverishment, and destruction of peasant and artisan spheres. These outcomes came

about through several channels: the import-substitution strategy for growth depended on the

import of capital goods and technical knowledge, which drained resources from the

domestic economy; savings rates were low and the market limited, so capital for investment

had to come from heavily taxed peasant and artisan sectors; to keep wages in the export

sector low, food prices were kept low at the expense of small domestic producers; and large

37 Most Marxist theories assume a marked dichotomy between feudal and capitalist economies. In feudal economiessurplus is expropriated through direct coercion or control over labor, possibly backed up by distortionary policies. In capitalisteconomies, by contrast, surplus can be expropriated even under perfectly competitive markets with voluntary transactions.Roemer (1982) shows this to be a consequence of wealth inequality and credit constraints.

38

farmers often received credit subsidies and other special benefits intended to bring about

rapid technical change and mechanization in the "modern" agricultural sector.

Thus a functional dualism emerged between the large-scale farms and the small

plots cultivated by farm workers or small landowners. These workers earned below-

subsistence wages on the large farms and fulfilled their subsistence needs with output from

their tiny farms. The two farm sectors were mutually dependent in a single dualistic system.

With population growth and mechanization (often subsidized), labor supply

outstripped labor demand, and peasant households tended to disintegrate. Workers and

peasant families migrated to cities in search of work, where a protected modern sector

generating large profits and high wages for a few coexisted with a growing informal sector

characterized by low wages. Thus functional dualism was recreated in urban areas.

According to this view the main factor influencing the pattern of development prevails

is whether or not the bourgeoisie is aligned with or against the working class. Where the

bourgeoisie was weak, it joined forces with foreign capitalists and the landed elite against

workers, resulting in dualistic patterns of development. By contrast, where the bourgeoisie

was strong, it aligned workers and peasants against the landed elite, leading to articulated

development.38

Therefore, to de Janvry, increasing the political participation by the poor, by

enhancing their potential for collective action, is key to bringing about increased efficiency

and sustained and equitable growth. In the long run the only feasible way to achieve this is

to increase the productive capacity of the rural population. De Janvry strongly advocates

that governments increase their spending on schools and health care facilities for the rural

poor. to improve their ability to participate in the political process. But the adoption of such

“social pact” policies is itself a political decision. Few social pacts have survived in Latin

America for prolonged periods of time.

The Marxist analyses discussed above aim to explain the entire circle of economic

and political interactions presented in Figure 1. Yet they often fail to recognize sufficiently

that in predominantly capitalist systems there are a wide range of growth-reducing policies

38 Note the similarity to the discussion of the capital intensive path to state formation by Tilly (1990).

39

that will, in the long run, not benefit any of the interest groups involved in policymaking. The

resource dissipation and economic stagnation so prevalent in many developing countries is

attributed largely to the peripheral role of these economies in the international division of

labor. Little attention is paid to the wide range of growth-reducing policies that would not in

the long-run benefit any of the interest groups involved in policy-making. This tends to

divert attention away from analyzing the impact of the distortions and from pursuing

alternative explanations of their origin. What needs to be better understood are the

conditions under which rational pursuit of economic self-interest can lead to political

outcomes that are detrimental to growth.

Rueschemeyer, Stephens, and Stephens (1992), building on earlier work by Moore

(1966), further explain the role of political coalitions in affecting policy outcomes. General

policy outcomes are the result of a contest between (repressive) landlords, whose wealth

resulted from access to cheap labor and sometimes protection from foreign competition,

and a bourgeoisie whose interests were more closely aligned with broad-based economic

growth and democratic development. Rueschemeyer Stephens, and Stephens observe that

at early stages of development all over the world, large landlords derived their wealth from

cheap labor, the availability of which was assured by coercive legislation or discriminatory

taxation of free peasants. By contrast, the bourgeoisie were in an ambivalent position,

supporting landlords where they had originated in a landlord-based nobility, but aligning with

workers where they had not. Societies in which the bourgeoisie aligned with landlords were

often characterized by low product diversification, concentration on heavy industry, and

protection from foreign competition (upon which the nobility depended for its economic

welfare). Their transition to democracy was often hindered by autocratic and dictatorial

episodes. By contrast, societies in which landlords were never powerful (because of

material conditions) were characterized by a relatively high degree of mobility, high

specialization, economic growth, openness, and a smooth transition to democracy.

In this context an authoritarian coalition comprising the state, labor-repressive

landlords, and a dependent bourgeoisie was most likely to arise where economic activity

was concentrated in agriculture and a large number of the high-level bureaucrats came from

the landed class; landowners were economically more important than the industry-based

bourgeoisie (either because there were few industries or because landlords owned most of

them); the bourgeoisie was dependent on the state, which provided industrial protection or

40

cheap credit and infrastructure; and the peasantry had little or no ability for politically vocal

resistance or revolution because of material conditions, a past history of extractive taxation,

and the abolition of communal institutions.

7. THE ADOPTION OF GROWTH-REDUCING POLICIES

In this section we return to the key questions that motivate this essay: what induces

societies to adopt growth-reducing policies and why do such policies persist? Historical

analysis and the theory of public choice suggest that inefficient policies are likely to be

adopted when the conditions for competitive bargaining between interest groups are not

metan issue that is closely related to material conditions and initial endowments of

specific groups. Here, we elaborate on this point and consider the importance of institutions

and organizational residues for policy formulation.

7.1 Initial conditions

An unequal distribution of initial endowments in environments where financial

markets are imperfect and credit is rationed can prevent a large proportion of the population

from making productive investments. In fact, a number of recent cross-sectional studies

have found a robust negative relationship between initial levels of inequality in the

distribution of income or wealth and subsequent growth (Alesina and Rodrik 1994; Persson

and Tabellini 1994; Deininger and Squire 1996). Several early studies sought to explain this

relationship as resulting from an unproductive but costly redistribution from the rich to the

poor which was imposed by the “median voter”.39 However this explanation does not accord

with the observation that the poor are less likely than others to participate in the political

process and with the failure to find an empirical association between the degree of

redistribution and lower growth. Recent models that incorporate a richer set of empirical

regularities point to the possibility of multiple steady states, which are determined by a

combination of initial conditions and endogenous institutional arrangements in the economy.

39 The argument is that the more unequal is the distribution of wealth or income, the further from the average will bethe median voter, and the higher is the tax rate he approves on wealth or income. The higher is the tax rate, the lower are theincentives for the wealthy to invest in productive activities, and thus the lower is the growth rate of the economy. Societies withvery unequal distribution of wealth or income should therefore be characterized by high tax rates on the rich and low growth.

41

Bourguignon and Verdier (forthcoming) develop a model in which political

participation depends on the educational status of a person (only educated individuals can

vote). Because of the absence of capital markets, individuals with endowments below a

minimum level will not be able to acquire human capitaleven though it is privately

profitableunless they receive an education subsidy. They will not therefore be able to

participate in the political process. Educating the poor will always result in higher growth.

But, educating the poor will lead to the ultimate loss of political control of the oligarchy (the

class of individuals with the means to privately finance education). Depending on the initial

distribution of income and the size of the educational externality (the benefits to society

from educating the poor), the steady state will involve a pure oligarchy with no growth, a

ruling oligarchy that accommodates a middle class without giving up power and moderate

growth, or a democracy with income redistribution and fast growth.

Benabou (1994) goes one step further, using a stochastic growth model with

incomplete asset markets. In his model the rich have more political influence than the poor,

and citizens vote democratically on proposed progressive taxation and redistribution

schemes. Thus redistributions that would increase aggregate welfare receive less political

support in societies with unequal wealth and income distributions than in egalitarian

societies (leading to further increases in inequality). Two stable steady states emerge, one

with high income and wealth inequality, and little redistribution, and one with low income and

wealth inequality, and higher redistribution. Economies with greater redistribution will grow

faster if the productivity advantage from reallocating resources outweigh the distortions

introduced by redistributive taxation.

What is common to these models is that initial conditions determine which of the

feasible equilibria will be attained. Without significant exogenous changes in these

conditions (including the underlying technical relationships, or the power structure within

society), it is unlikely that an economy will move from one equilibrium to another.

7.2 Lack of institutions

The importance of institutions can be explained in a context of self-interested

politicians who myopically or strategically pursue short-term goals, even when the resulting

policies would reduce long-term growth. The state's ability to commit to taking particular

actions can be crucial in a strategic setting (Rodrik 1992). A weak state, which has little

42

ability to enforce contracts or take actions, will systematically underprovide economically

desirable public goods and, at the same time, undertake politically motivated interventions

that are economically harmful. While all states may be using the same instruments, the

weak state consistently chooses wrong policies, encouraging rent seeking and unproductive

spending rather than productive investment.40

Evidence has accumulated over the past decades that macroeconomic stability, the

real exchange rate, and nonagricultural protection are major influences on agricultural

growth (Gardner forthcoming; Krueger, Shiff, and Valdés 1991). We therefore need to look

at the types of institutions that can ensure macroeconomic stability and an appropriate

foreign exchange regime.

A large number of empirical studies comparing institutions across countries show

that the existence of independent central banks and mechanisms that ensure budgetary

discipline, political stability, fiscal decentralization, and free trade are generally associated

with better economic performance, even if other factors are taken into account.

The existence of independent central banks seems to be consistently associated

with better economic performance (Cukierman, Webb, and Neyapti 1992). Independent

central banks have forced even countries of the Organisation of Economic Co-operation

and Development (OECD) to adopt sounder fiscal policies (Alesina, Grilli, and Milesi-Ferretti

1993). Furthermore, institutional arrangements, such as a "no deficit carryover” rule, and

expenditure limitations, such as those adopted in many states of the United States, are

strongly correlated with more rapid—and less costly—adjustment to unexpected fiscal

deficits, such as occurred during the economic downturn of the 1980s (Poterba 1994).

Theory also suggests that free trade can reduce a government’s ability to rely on and

benefit from monetary expansion, since monetary expansion affects exchange rates more

40 The importance of the state is shown by the example of Korea, which provides subsidies to industries. In contrast toattempts in other countries, the subsidies have succeeded in stimulating productive investment, which appears to be related to thegovernment’s ability to base the subsidies on transparent criteria and to credibly threaten to withdraw them in case ofnoncompliance. Grabowski (1994) proposes a similar game-theoretic explanation, based on a game between a government thatprovides investment subsidies and the private sector. In his model everyone would be better off in the long run if the subsidieswere invested. But, the firm with a sufficiently short time horizon would rather consume the subsidies and bribe governmentofficials just enough to make them collaborate, leading to a net loss for society. In a repeated game context, the credible threat ofimmediate withdrawal of the subsidy can lead to a Pareto-optimal outcome.

43

in open economies than in closed ones. A study looking at empirical evidence for 114

countries found that the degree of openness is highly and significantly correlated with lower

inflation, greater political stability, and greater independence of the central bankthus also

demonstrating the mutually reinforcing character of these institutions (Romer 1993). The

result is robust for different subsamples, but vanishes for a sample containing only OECD

countries. This breakdown suggests that OECD countries have other institutions preventing

short-sightedness on the part of politicians.

A system of fiscal federalism can limit arbitrary behavior of the central government

(Casella and Frey 1992). Establishment of independent but accountable institutions at

lower levels of government can strengthen the state, while at the same time placing limits

on its ability to confiscate the wealth of its citizens by arbitrarily changing the rules of the

game (Weingast 1992). The more mobile are its citizens, the more important is competition

between different levels of government. But, this competition could be jeopardized if strong

and enforceable systems of accountability and monitoring by citizens and the central

government are lacking, leading to dominance of local institutions by the rural elite.

The term political stability has often been used to describe the presence of strong,

impartial, and accessible institutions; an unambiguous division of power between different

branches of government; and their mutual control and vigilance. Political stability promotes

private as well as public investment.41 Political instability will reduce private investment as it

directly or indirectly threatens the security of such investment. The empirical evidence

contains many examples of the close relationship between political instability, low private

investment, and low growth (Edwards and Tabellini 1991; Edwards 1994).

Political instability would also likely affect the nature of public investment. In strong

states rulers can invest in public goods that enhance growth. In weak states, the lack of

broad popular support and the inability to hold on to power indefinitely shortens the rulers’

time horizons and forces them to redistribute resources as bribes to potential contenders

(Moe 1990; Wintrobe 1990). Redistributing resources may eventually require more revenue

than can be sustainably extracted from the farm sector, causing small farmers to revert to

41 Political stability is a necessary, but not sufficient condition for economic growth. There are many examples ofstable, but repressive states, which failed to promote investment or growth.

44

subsistence production (or the informal urban labor market), and outputs and tax revenue to

fall. Additionally, the policies may lead to a collapse of foreign exchange reserves needed

to purchase imported inputs for agriculture and manufacturing, leaving the state with crises

of fiscal revenue, foreign exchange, and domestic output. Empirical studies have found

some evidence that government weakness played an important role in the accumulation of

foreign debt in many countries during in the 1980s (Özler and Tabellini 1991) and that low

growth and political instability are mutually reinforcing (Alesina, et al. 1992).

Many developing countries inherited institutions that benefit ruling groups at the

expense of large portions of the population. The resources available to the elite—natural

resources, rents, revenues from commodity exports, and, often, outside economic and

military assistance—helped maintain productivity-reducing policy regimes for prolonged

periods of time and eliminated the budget constraint that is critical for the attainment of

optimal policy outcomes. This outflow made political leadership a highly desired source of

patronage and led to the dissipation of resources on a grand scale through rent seeking. In

such situations, domestic interest groups may fiercely resist the establishment of

independent institutions, such as judiciaries and independent central banks.

8. Policy change

How, and under what conditions, can policies that facilitate growth and reduce

inequality and poverty (equation 4) be enacted and sustained? Experience suggests that

external shocks do not generally trigger or lead to the maintenance of major growth-

enhancing policy reforms. Nor does internal revolt. However, if exogenous shocks lead to

a fiscal crisis of the state, then the resulting changes in the bargaining position of groups

can provide the opportunities to initiate reform and establish institutions that—possibly

irreversibly—change the character of subsequent political interaction between interest

groups.

8.1 Exogenous shocks

The impact of exogenous shocks depends critically on the fiscal position of the state

and the institutional and political environment. On the one hand, the state may wish to

compensate groups that are hurt as a result of the shock (Magee, Brock, and Young 1989).

On the other hand, negative shocks may reduce the state's ability to provide compensation,

45

thus decreasing the payoff to redistribution and providing an opportunity for comprehensive

policy reform (Drazen and Grilli 1993). The outcome depends on the state’s overall fiscal

capacity. A government with liquid assets and an unrestricted ability to borrow can

compensate small groups hurt by adverse shocks or, conversely, initiate redistributive

policies in response to positive shocks. But, a government without such resources may be

forced to undertake policy reform.

It is not surprising that external shocks, such as changes in the terms or trade or the

cost of borrowing in international markets, result in unpredictable outcomes. An external

shock will have differential impacts on individual interest groups, depending on the nature of

the shock and the country affected. Interest groups will agree to changes only when the

result of the change would be better than the alternatives. Thus even when reforms would

enhance aggregate efficiency, they may be delayed if they are not acceptable to certain

interest groups (Alesina and Drazen 1991). Inequality in income, wealth, or composition of

assets may provide opportunities to some groups to hold out in the process of reform and

impose the cost of adjustment on others (for example, holders of wealth may shift assets

abroad to avoid an inflationary tax, an option not available to all). In highly polarized

societies, the rich may be able to wait until the poor are willing to shoulder most of the

burdens associated with reform.

This model can also explain other behaviors of individual economic agents or

interest groups. An industry hurt by an adverse shock will decide to lobby for

compensation—rather than adjust—if it expects politicians to react favorably to the request.

The expectations of the industry will depend on the past history of awarding protection to

specific sectors, in addition to the state’s aggregate fiscal capacity (Brainard and Verdier

1994).

The effect of the population collapse that occurred with the Black Death shows how

identical exogenous shocks can have highly varied impacts. This catastrophe, which killed

between one-third and one-half of the population in Western Europe between 1350 and

1500 (most seriously between 1347-51), led to an improvement of peasant rights in the

western zone of Europe, but to a second enserfment and reduction of peasant rights in the

eastern zone (for example, Poland and the former East Germany). Brenner (1977) was the

first to suggest that differences in the institutional environments of the two regions may

46

have led to the different outcomes. The western zone, which was more densely populated,

was characterized by strong village institutions that developed to protect and regulate village

commons, and provided peasants with bargaining power to establish rents, the ability to

enforce rights of inheritance, and the right to elect village mayors and priests. These

institutions were independent of state control and could defend their rights against

incursions by landlords. By contrast, the eastern zone was characterized by a high degree

of centralization, the strong leadership of landlords, an absence of common lands, and little

tradition of protecting rights of peasants.

Evidence contradicts the hypothesis that external shocks, on their own, bring about

growth-enhancing policy reforms. Positive external shocks often did not lead to an

improvement in the fiscal position of governments. Where governments, rather than private

entrepreneurs, unexpectedly gained access to large amounts of export revenues, they were

often unable to either save the revenue inflows for use when the conditions returned to

normal or to resist political pressure for redistribution.42 Some countries experiencing

commodity booms went on spending binges that, in political environments characterized by

clientélism and lack of planning capacity, did not increase the long-term productive capacity

of the economy. Often, the exchange rate appreciation that accompanied the commodity

boom (Dutch disease) and government spending hurt agricultural producers, increasing

polarization rather than reducing it. Cross-country evidence clearly shows that in the vast

majority of cases commodity booms reinforced preexisting social, political, and economic

divisions rather than reducing or eliminating them (Little, et al. 1993). In response to

negative shocks occurring later, governments often imposed import restrictions as they tried

to protect the import substitution industries founded during the boom (and possibly the

ruling party’s power base)—a goal that prevented them from devaluing the currency. These

policies generally hurt the tradeable sectors (including agriculture), worsened existing social

inequities, and set in motion further rent seeking efforts and pressures for higher deficits.

Empirical and historical studies show that when external shocks trigger or aggravate

a fiscal crisis, changes in the institutional and policy environment often result. A fiscal crisis

42 The only examples where such a result was at least partly achieved are cases in which the foreign exchange revenuespartly accrued to private organizations such as the coffee growers' association in Colombia (Cárdenas and Pontón 1995), or inKenya (Bevan, Collier, and Gunning 1993).

47

makes the aggregate budget constraint more binding, reducing the potential for obfuscation

and other forms of misinformation, and increasing the bargaining power of groups that have

access to resources or information. However, reform efforts, once initiated, may not be

sustained.

A fiscal crisis can make it impossible for those in power to buy off or suppress an

emerging alternative coalition. Historically, state financial distress, a high degree of

intraelite competition, and a potential for mass mobilization have been identified as

important preconditions of reform (Goldstone 1991).43 Most developing-country reforms

were initiated in response to deteriorating economic conditions, such as balance of payment

crises, inflation, capital flight, and the obvious failure of the state to provide the social

services or favors demanded by politically influential groups (Bates and Krueger 1993). By

contrast, reform has often been avoided, or stabilization plans abandoned, where there

were alternative ways to avert crises, such as by increasing taxation of politically powerless

groups or by exploiting and selling natural resources. This is in line with the importance of

fiscal crises in eliminating well-established interest-group equilibria, as emphasized by

Olson (1993) and recently confirmed empirically by Ben-David and Papell (1995).

8.2 Revolt

Exogenous shocks and resulting fiscal crises can trigger revolt. But revolt may also

occur independently, as illustrated by a number of theoretical models that focus mainly on

the use of revolt, or the threat of revolt, in a bargaining game between interest groups.

Peasants who are disadvantaged by existing policies are unlikely to initiate revolt without

strong coalition partners. Even if successful in achieving immediate demands, peasant

revolts have rarely brought about lasting reforms and improvements in peasant welfare.44

43 The endogeneity of these variables, which may be related to lack of economic growth and a high degree ofunproductive activity, is not explicitly considered.

44 Revolt may take many forms, from passive resistance and small scale violence to massive rebellions. Persons orgroups harmed by existing policies often engage in passive or small scale active resistance by (Scott 1985). The theoreticalliterature has recently explored these activities. If the poor do not have the ability to expropriate resources from the wealthythrough the ballot box, they may try to obtain resources by pilfering and other kinds of extralegal expropriative activities. If themarginal return to banditry exceeds the marginal return to wage employment, landlords would favor distributing just the quantityof land needed to prevent peasants from engaging in banditry (Grossman 1994). This may explain why in some countries, landreform was undertaken only after more coercive means to ensure peace were no longer feasible. A similar Nash "equilibriumpath of land reform" can be derived by treating the power of landlords and peasants as exogenously given (Horowitz 1993).

48

Successful peasant revolts occurred only when the state was weak or in fiscal crisis,

making it difficult for rulers to co-opt the revolutionaries and their coalition partners through

concessions, and making it possible for peasants to enlist powerful allies inside or outside

the state apparatus, in particular those with financial and military resources to support their

cause. Revolts were also more likely where the state had attacked peasants’ collective

identity, where revolutionary leaders had promised tangible improvements and addressed

specific grievances, where the potential benefits and/or the probability of success were high,

and where other avenues of political articulation (or co-optation of a part of the peasantry)

were not available (Tilly 1990).45

Even if numerically superior, peasants' low potential for collective action makes it

virtually impossible for their revolts to succeed without militarily powerful coalition partners.

Such a coalition enables urban-based revolutionarieswho appreciate the access to food

and the local knowledge of places to serve as a hideoutsto harness peasant discontent

through promises or coercion (Kriger 1992; Palmer 1977). Most revolutionaries, therefore,

supported programs that selectively met peasants' demands, such as those providing

access to land or eliminating legal discrimination. Additionally, states seeking to quiet

peasant unrest adopted such programs.

Rural discontent can, even without the threat of major revolt, cause powerful groups

to undertake limited reform and accept the associated loss of some resources. However,

such reforms are not necessarily socially beneficial, as is clearly illustrated by the failures of

poorly designed land reform programs and the modernization of hacienda systems in

reaction to the threat of massive peasant unrest in the early 1960s in many Latin American

countries (de Janvry and Sadoulet 1990).

Peasants' lack of potential for collective action appears to be responsible for the

almost universal failure of revolts to improve their welfare, even in cases where the revolts

succeed and are characterized by strong peasant participation. There are numerous cases

45 Elimination of the traditional insurance and judicial methods practiced in communal systems appears to be at theroot of many peasant revolts in the history of industrial and developing countries alike. Threats to communal tenure andpeasants' right to elect the village mayor and priest were a key issue in the German Bauernkrieg. In this case, the other conditionsfor revolt were satisfied as well: other avenues had been tried unsuccessfully, the traditional establishment was in financial crisis,its ideological basis was weakened by the Protestant reformation, and there was a potential for tangible improvement in thematerial situation of the average peasant (Magagna 1991).

49

of measures being enacted after a revolt which directly favored the urban against the rural

population (Nicaragua), settled political cronies on marginal lands but provided little more

than promises for the rest (Zimbabwe), or simply avoided distributing land to individual

farmers because doing so would conflict with the ideological goals of the state (Cuba).

Because these measures were often associated with large inefficiencies—by forcing

agriculture onto an excessively capital-intensive path or by collectivizing farms—they did not

increase the stability of the postrevolutionary systems.

8.3 Factors that enhance sustainability of reforms

While a fiscal crisis is usually necessary for initiating reform, a politically vocal

coalition supporting reform is necessary to ensure that reform is durable and successful.

Sustained improvements in policy outcomes appear to have been limited to situations in

which the fiscal crisis led to the formation of institutions that allowed the participation of

more groups in the political process or increased individuals’ ability to demand enforcement

of rules. In the context of fiscal crises technical advice, assistance that helps specific

interest groups articulate their demands politically, and provision of resources by outside

agents can strongly affect the outcome of the reform process. Reforms are more

sustainable when the outcomes are viewed as fair, rather than being challenged by losers.

• Character of supporting coalition. The durability of reform requires the

support of a coalition of groups benefiting from reform. Building coalitions is easier if the

distortions associated with earlier policies are large or groups benefiting from earlier policies

are weakened, a range of feasible policy options is available, the state has sufficient

technical and administrative capacity, and the reform effort is credible (Haggard and

Kaufman 1992).

The creation and strengthening of a coalition supporting reform appears critical to

ensuring success. Where potential beneficiaries are not sufficiently organized politically or

where there is little policy dialogue that allows the government to explain and fine-tune its

policies, reform programs often encounter great difficulties. Increased political

representation is particularly important where the beneficiaries of reform are peasants or

small traders who are dispersed and have little political voice.

50

• Institutions supporting fiscal discipline. Ability to exercise strong central fiscal

control, through the central bank and the ministry of finance is critical to maintaining

budgetary discipline, keeping inflation down, and preventing special interest groups from

undermining reform efforts.46 For a number of reasons, the ability to exert such control is

greatly enhanced if reform is undertaken swiftly. First, rapid action is likely to return

economies to a growth path faster; step-wise implementation of reform can be justified on

economic grounds only if rapid action risks backlash and policy reversal (Wei 1991).

Second, quick implementation of reform allows an incoming government to use honeymoon

periods and signal its commitment, which enhance its credibility (Rodrik 1989). Third,

where reforms are implemented quickly, opportunities for interest groups to organize in

opposition are minimized.

• International support can make reform efforts more credible and provide

access to international credit and technical assistance (Santaella 1993). However, the

availability of international finance can also delay stabilization, for example, by propping up

an unsustainable regime. In highly polarized countries an important side effect of external

assistance may be the initiation of a comprehensive policy dialogue that includes the

opposition (Haggard and Kaufman 1994).

• Analytical capacity. In many reform efforts analytical capacity, often provided

by technocrats in enclaves isolated from political pressures, is indispensable for analyzing

the current economic situation, providing technically-sound solutions, and ensuring

continuous adherence to the reform effort. A necessary technical condition for the ability to

exercise fiscal control is that basic information on the economic situation is available and

that the incentive structures in the bureaucracy ensure impartial implementation.47

46 Experience does not confirm the conventional wisdom that military regimes have an advantage in exercising suchcontrol. The cases (Argentina, Brazil, Nigeria) where populist or ethnic cleavages frustrated military and civilian governmentsalike, as well as examples presented in the literature on the coup-trap (Londregan and Poole 1990), caution against such aromantic view of strong leadership.

47 If policy reform requires significant reallocation of factors across industries, it is essential that the financial systemfunctions well. For Sri Lanka, Athukorala and Rajapatirana (1993) show that financial sector policies supported the beneficialeffects of trade liberalization on both the demand and supply sides. On the demand side, attractive returns on financial assetsencouraged people to save their increased incomes rather than spend it on nontradeableswhich otherwise would have led topremature appreciation of the real exchange rate and undermined the competitiveness of the tradable sector. On the supply side,increased savings provided funds to invest in the export sectoras indicated by the increasing credit flows to small enterprises.

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Combining macroeconomic stabilization, which produces large gains, with trade

liberalization, in which most of the social gain comes at the expense of well-defined interest

groups, has made policy reforms much more acceptable to citizens (Rodrik 1992).

Since policy reform presents risks for some individuals and groups, an important

issue is the provision of social safety nets.48 Providing a basic level of insurance for losers

greatly increases political support for reforms.49 Eichengreen (1992) argues that the

presence of social safety nets and investments that improved citizens’ access to education

and health facilities were instrumental in bringing about a social consensus during the

reconstruction in Western Europe after World War II. The existence of social safety nets

weakened support for nationalist forces, prevented conflict between groups with long-

standing animosity, and led to rapid economic growth.50

The process of reforming agricultural policies has accelerated in the 1990s in the

developing world. The triggers have been fiscal crises. Enhanced international support

through the General Agreement on Tariffs and Trade (GATT) negotiations, from the World

Trade Organization (WTO), and from the World Bank and bilateral donors has also been

important. Still, reforms of agricultural and agrarian policies have often lagged well behind

general macroeconomic reforms and structural adjustment.

A recent study of six developing countries, chosen because of their commitment to

agricultural policy reform in the 1980s and early 1990s, shows just how difficult the reform

process has been and how incomplete it remains (Gardener forthcoming).51 This result is

48 Hardy (1992) argues that lack of social safety nets is the main reason for governments' inability to close obsolete andinefficient state-owned enterprises. In many of the transforming economies state enterprises are the sole institutions reaching thepoor. This issue is even more important where state-owned enterprises recognize their significance and behave strategically.

49 Concerning the potential importance of insurance, Fernandez and Rodrik (1991) demonstrate that because thebeneficiaries of reform cannot be known ex ante, efficiency-enhancing reforms may not be adopted. Once reforms have beenadopted, the uncertainty is resolved. This can explain why reforms undertaken by autocratic regimes (Pinochet in Chile) maysurvive even when the countries adopt democratic political regimes.

50 Eichengreen (1992) argues that the most important impact of the Marshall Plan for Western Europe was that itfacilitated a social pact and reduced the political instability that had caused individuals to “hoard commodities and withholdeffort.” This provision of safety nets not only facilitated economic stability, allowed governments to balance budgets, andremoved the danger of confiscatory taxation that had caused potential investors to wait, but also provided critical support forproponents of a more market-oriented, rather than command-driven economic approach.

51 The countries were Chile, Ghana, Honduras, Indonesia, Madagascar, and Mexico. The study also included NewZealand, an OECD country, and Hungary, an economy in transition.

52

not surprising: distortionary agricultural and agrarian policies are often fully consistent with

underlying material conditions and the prevailing features of the political environment. They

are frequently linked to organizational residues, such as commodity boards, parastatals, or

collective farms. Their elimination and overall agrarian reform would benefit groups who

have poor potential for collective action and who are hard to include in postreform coalitions,

such as peasants, the landless, or dispersed consumers. Both governments and

beneficiaries have limited analytical capacity to evaluate the economic impact of reform.

And the real impact of policies is easy to obfuscate.

8.4 From taxation to protection: Is agriculture a special case?

A paradox that needs to be resolved is why countries of Western Europe, Japan,

Korea, and Taiwan have, during the past fifty years, enjoyed rapid industrial and agricultural

growth and dramatic reductions in rural poverty. Farms that rely primarily on the labor and

management of owner-operators dominate their agricultural sectors. Agricultural output has

risen dramatically in these countries in response to high real prices (usually above world

market levels) and other supports, turning most of the countries from net importers into net

exporters. Countries with the least comparative advantage in agriculture, such as Japan,

Norway, and Switzerland, have supported agriculture the most. The agricultural policies of

these countries have been modestly successful in supporting rural incomes, but they have

been costly to consumers and the state.

The shift of these Western European and East Asian countries to greater and

greater agricultural protection during the second half of the twentieth century illustrates how

the elements and processes discussed in this paper can illuminate complex political

processes.52 At the conclusion of World War II countries were left with a great number and

variety of policies, programs, and organizational residues put into place to manage food and

agricultural raw materials during the war. These could readily be put to different uses such

as agricultural protection and income support.

The land reforms implemented in Japan, Taiwan, and Korea led to rapid growth in

agricultural output and rural incomes. In all of the countries rising urban productivity and

53

incomes increased the opportunity cost of farming, and encouraged workers to migrate from

rural areas to cities. Reduced numbers of rural dwellers and rising incomes increased the

collective action potential of rural groups in general. Greater commercialization and

specialization of farming increased the collective action potential of narrowly focused

commodity-based groups. Rural-urban migration reduced the number of farmers, but did

not diminish the political representation of rural areas, since voting rules were not adjusted

to fully reflect changes in population distribution.

The commodity price boom brought about by the Korean War strengthened the

resolve of governments to maintain the security of national food supplies, further boosting

the political power of farmers. The food shortages of the early 1970s similarly spurred

countries to adopt policies to ensure national food supplies. Many of the policies initiated

during these years remain in place today.

In recent years attempts to reduce the distortions of farm policies have led to

adjustments in the Common Agricultural Policy of the European Union and the inclusion of

agriculture in the framework of the World Trade Organization. An in-depth analysis of the

factors contributing to these changes would be one important way of testing the empirical

usefulness of the principles outlined above. There seems to be a consensus that the two

main factors responsible for this change have been fiscal considerations (Gardner 1996)

and the establishment of international institutions, such as the GATT and the WTO, which

linked liberalization of agriculture to freer trade in other commodities.

9. MAIN IMPLICATIONS

In this section we discuss implications under three headings. First, we ask what are

the key regularities, and how can they be explained better with the theories and empirical

evidence assembled in this essay? We then discuss how the systematic introduction of

these elements would change the appropriate policies for agricultural development and

agrarian relations. We conclude the essay with suggestions on how to further improve

knowledge in this area through theoretical and applied research.

52 A number of articles reviewed here (for example, Hayami and Anderson 1986) have emphasized that many of thefactors that have been discussed in this review have been very relevant in explaining the transition to higher production.

54

9.1 Elements and regularities with explanatory power

The review of the literature shows that the political outcomes—which influence

agrarian relations and determine agricultural taxation, subsidization, and the provision of

public goods—result from political bargaining between interest groups, which usually takes

place within an economywide budget constraint. The decisions reached through bargaining

are more likely to be efficiency- and growth-enhancing when equally powerful interest

groups, which are aware of the aggregate government budget constraint and know the

economic implications of different policy options, participate; and when impartial institutions

facilitate participation of all groups in economic and political activities, and enforce

decisions. The greater is the deviation from these conditions, the greater is the potential for

efficiency-reducing outcomes. In addition, the costs will fall disproportionately on politically

underrepresented or powerless groups. The differences in the potential for collective action

and the degree of political articulation among groups involved in bargaining about

agricultural and agrarian policies is particularly striking.

• Peasants’ potential for collective action. Clearly, if other markets are

functioning reasonably well, organization of agricultural production in owner-operated family

farms would maximize production efficiency. Paradoxically, these family farmers are very

unlikely to act collectively. The material conditions of agricultural production—spatial

dispersion, seasonal work cycles, covariance of risk, and the associate market

imperfections under which family farmers operate—make it difficult for them to act

collectively and to be aware of the implications of different policy options. This difficulty also

limits their ability to use ideas, ideologies, and information and misinformation to their

advantage. The low potential for collective action among poor peasants explains why many

inefficient policy regimes persist. It also explains the striking inability of peasants to initiate

revolts in the absence of a nonrural coalition partner, and to transform successful revolts

into lasting political change.

• Rural elites’ potential for collective action. On the other hand, rural elites—

whether nobility or large-farmer interest groups—have very high collective action potential,

as experience in both industrial and developing countries demonstrates. Rural elites have

often been able to secure privileges and avoid taxation, while small family operators have

not been able to do so. And when fiscal crises, food supply emergencies, or threats of

55

peasant revolts forced the state to implement reforms, rural elites were frequently able to

preserve their privileges. For example, rural elites were often able to steer policies and

programs meant to increase rural productivity into capital-intensive investment programs for

large farms, thus perpetuating inequality and inefficiency. Where urban groups

implemented low food price policies, programs to compensate farmers benefited rural elites

almost exclusively, to the detriment of rural growth and the rural poor.

• Variations in material conditions. Such variations in agriculture over space

and time, and in the associated imperfections in financial, insurance, and land markets have

powerful impacts not only on economic outcomes and accumulation processes, but also on

the political and institutional environment and a broad range of political outcomes.

Population density, in particular, has been used as an explanatory variable in many sections

of this paper. Material conditions do change, although slowly, through accumulation

processes. While the government’s ability to alter the underlying material conditions is

therefore limited, there are many examples of how central government-financing of basic

health, nutrition, infrastructure, research and extension, and services can reduce the impact

of spacial dispersion, covariance of risk, and lack of knowledgeand enhance growth and

diversification of rural activity. In the process many of the market imperfections so

prevalent in rural areas of low-income countries are reduced.

• Institutional and political environment provides incentives to individuals and

groups to invest, accumulate, and engage in political activity. In particular, the presence or

absence of clearly defined rights to own or use property, and of independent institutions

affects the propensity and ability of different groups to engage in political bargaining and

rent seeking, rather than in productive activities. While in the long-run the features of the

institutional and political environment are endogenous, they also embody organizational

residues, which, at any given time, have independent impacts on the bargaining processes

that determine political outcomes.

• The negative impacts of inequality. The literature reviewed here indicates

that in environments characterized by imperfections in financial and insurance markets,

income inequality may help perpetuate poverty and dualistic development. Credit rationing,

imperfect insurance and land markets, and the lumpiness of investments prevalent in rural

areas limit the ability of the poor to acquire land, draft animals, machinery, and other

56

equipment required to operate even small farms. The same conditions often force poor

people to liquidate stocks of productive capital in times of distress.

Income inequality may also increase the likelihood that governments will adopt

policies and programs that reduce efficiency. There are three main reasons why. First,

inequality reduces the participation of the poor in political processes, both directly and

indirectly. This in turn, reduces the likelihood that the poor have access to education and

health care services, and other services that would contribute to growth. Inequality may

hinder the establishment of independent and impartial institutions, and the enforcement of

binding rules, because these might reduce the benefits of the privileged. Inequality makes it

easier for the wealthy to hold out in political bargaining, either directly through capital flight.

It therefore makes it more difficult for societies to respond quickly and optimally to external

shocks, rather than adopting growth-reducing policies, which, nonetheless, protect the

privileges of the wealthy.

• External shocks, the fiscal position of the state, and policy change. The

historical and institutional economics literature shows clearly how fiscal crises of the state—

often triggered or aggravated by an external shock—frequently bring about lasting changes

in policies and institutions. Fiscal crises, under certain conditions, force the state to devolve

some of its power to independent institutions in exchange for financial assistance to meet its

immediate needs. This devolution may give rise to independent legal, political, and

economic institutions, which subsequently have positive impacts on policy choices and

growth.

External shocks such as changes in the terms of trade can have widely varied

impacts, depending on the material and political environment, and depending on the fiscal

position of the state. In the event of negative exogenous shocks the state may attempt to

compensate influential coalition partners. If the state has sufficient cash reserves or access

to credit, it is able to assist them through the use of borrowing or temporary and relatively

nondistortionary transfers from fiscal resources. If, on the other hand, the government is in

financial difficulty, it may provide compensation by introducing distortions that have no fiscal

costfor example, by allocating large tracts of frontier land or restricting the importation of

goods competing with those produced by coalition members. People who are not members

of the coalition pay the costs. Positive external shocks can also have negative

57

consequences. If a government has difficulty saving the temporary inflow, income

inequality is likely to rise, which may increase the country’s economic and political

vulnerability to negative shocks.

Finally, under certain conditions the political and economic reforms brought about in

response to a fiscal crisis may not be stable. Policy reversals are most likely to occur when

the state has insufficient means to finance growth-enhancing public goods, social safety

nets, and transfers to politically articulated groups to reinforce support for reform.

Paradoxically, therefore, a fiscal crisis, the main initiator of reform, may also ultimately

mean that the reforms cannot be sustained. Rapid restoration of fiscal balance following

the fiscal crisis, and renewed access to international credit markets, are therefore likely to

be key to producing lasting reform.

• External alliances. Because of the importance of fiscal crises in triggering

reform and because of the critical need for access to fiscal resources to sustain reform,

external firms, international organizations, or foreign governments that provide financial

resources, military hardware, or food to states in fiscal crisis have exceptional leverage in

shaping policy. Whether they encourage the adoption of growth-enhancing and poverty-

reducing policy changes depends on their motives and wisdom of those providing the

assistance.

9.2 Policy advice when policies, organizations, and institutions are

endogenous

Economists and international institutions generally advises countries to adopt

efficiency- or growth-enhancing policies. Nevertheless, it is well known that countries are

most likely to initiate reform when fiscal or foreign exchange crises make reform essential,

and, at the same time, weaken the state’s ability to reward members of the coalition who

supported the old policy regime. When these conditions prevail, domestic or foreign donors

or lenders can use their financial leverage to persuade countries to adopt their policy

prescriptions. It is no accident that the World Bank, regional development banks, and

bilateral aid agencies adopted policy-based, quick-disbursing loans just as the second oil

shock created fiscal crises for many governments.

58

Consistent with conclusions of the literature reviewed here, studies examining the

impact of World Bank policy-based lending show that the reforms will not lead to sustained

improvements in policies unless they are supported by a strong postreform coalition. Thus

the World Bank’s emphasis on “government ownership” of the reform agenda. Indeed, this

review suggests that bargaining equilibria among self-interested groups may often lead to

stable but inefficient policy outcomes. In these situations the leverage of policy-based

lending may not be enough to force adoption of first-best policies.

An additional complication shown in the literature review is that policies and

programs that are normally very desirable may not enhance efficiency under some material

conditions. For example, fully private land rights where population densities are very low

may not lead to higher efficiency and greater growth. In addition, material conditions may

affect the sustainability of reform: where population density is very low, rural elites are

strong and have ample opportunities to form alliances with other interest groups resistant to

change. Policy advice must take account of these complicating factors.

Policy advice should also be based on a greater understanding of the opportunities

for reform that are associated with crises, including—in addition to fiscal crises—political

crises caused, for example, by the threat of peasant revolts. Several of the successful East

Asian land reforms were reactions to communist takeovers following World War II, while the

less successful Latin American ones were associated with the Alliance of Progress following

the Cuban Revolution. The emergence of land reform programs in Brazil has also been

triggered by massive peasant mobilization, threatening a political crisis. It is during times of

crisis that urban elites may be more willing and able to check the power of rural elites.

Policy change, in addition to affecting efficiency and income distribution, also

modifies the bargaining power of interest groups and their ability to participate in the political

process. Successful land reform improves the political articulation of the beneficiaries.

Privatization of parastatals not only reduces fiscal costs and improves competition, but may

also eliminate organizational residues that could lead to the adoption of future distortionary

policies. Similarly, openness of the trade regime reduces the power of domestic interest

groups and encourages governments to maintain budgetary discipline. The international

institutions and bilateral donors should systematically consider these possible outcomes

when formulating their policy advice.

59

The importance of income equality. The finding that increased income equality can

generate superior economic and political outcomes leads to several conclusions. Primary

education and health services, especially for the poor, rural inhabitants, and women, are

important not only because they foster growth and help reduce poverty through several

well-known channels, but also because they reduce income inequality, and thereby enhance

the collective action potential of the poor. Safety nets are necessary because they enable

the poor to avoid liquidating their stocks of productive assets in times of crisis, leading to

more equal distribution of wealth—which is important for the political environment in the

long-run. Redistributive land reform not only gives land to more efficient producers, but also

reduces credit market imperfections, which lead to improved investment decisions by the

poor. Greater wealth also increases the ability of the poor to directly participate in the

political process.

In view of the importance of independent institutions for the sustainability of policy

reforms, it is not surprising that new types of policy conditionality in adjustment lending

programs have recently been introduced that focus on enhancing the power of independent

institutions—including the establishment of independent central banks and judiciaries.

Decentralization of political, fiscal, and administrative power may change incentive

structures for political participation and the ability of previously powerless groups to

participate, thus creating conditions for bargaining which are more conducive to efficiency.

Reforming local governments to allow for greater competition improves transparency and

reduces the power of rural elites to appropriate benefits. The rise of civil society institutions,

especially in a context of greater decentralization, leads to greater participation. Groups

that were previously unrepresented, such as small farmers, can become much more

involved in choosing and implementing projects that they benefit from. Participation also

strengthens the social capital of poor beneficiaries to influence policy decisions. Finally,

documenting and measuring the impact of policies, organizations, and public expenditures

on efficiency, growth and rural poverty are needed to reduce the possibility that interest

groups succeed in using misinformation and obfuscation as a political tool. But it is not

sufficient to produce the knowledge. Poor and vulnerable groups must have access to it so

that they no longer have to operate at a disadvantage.

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9.3 Toward greater predictive power

We are a long way from being able to explain the differences between the four

groups of countries, and individual countries more generally. Instead, we have identified a

number of key factors that must form part of an explanatory framework. We have also

identified the factors and regularities that can be used to explain major changes in

agricultural policy and that need to be taken into account in providing policy advice. But our

knowledge is very limited in certain areas—for example, the impact of ideas as generators

or facilitators of policy change—and remains poorly integrated across subfields and schools

of social science.

Thus there is a great need to develop a more unified theory of a political economy of

agriculture and agrarian relations that can be tested empirically. Such a theory must be

embedded in the theories of institutional development, state formation, and political

decisionmaking, which deal with issues well beyond agriculture and the rural economy.

Insights from many disciplines and analytical traditions, from neoclassical economics to

historical materialism, provide important elements of such a theory.

How would one develop a better theoretical framework and test whether it is capable

of quantitative analysis and predictive power? Developing a theoretical framework is most

difficult when all changes in a country—the political and institutional environment, the

political and economic outcomes, and the material conditions—are endogenous. Partial

theories that try to explain only some elements can omit important explanatory variables, or

treat all the right-hand side variables as exogenous. These theories often lead to erroneous

attribution of causality, especially in cross-country comparisons. While it is possible to

circumvent this problem by using sequential approaches and taking the material and/or

political and institutional conditions as largely exogenous, unobserved or unaccounted for

variables (such as “fixed effects”) may still undermine the analysis. In truth, only natural

endowments and external events are strictly exogenous.

One may therefore initially look only at the impact of changes or shocks in the

external environment on the policies, institutions, and programs of a country. Fully

modeling the long-term dynamics of political, institutional, and economic change—even

though desirable in order to focus on the long-run consequences of alternative agricultural

and agrarian policies—is a much more distant goal. Predictions of how the political

61

environment will change in response to external or exogenous shocks—including natural

disasters and changes in ideas, the potential for alliances, prices, opportunities for trade

and borrowing, and technology—can be tested. The first task, then, is to build a model or

theory capable of predicting changes in the political environment in response to external

shocks. For this job one can use comparative static models and take many of the material

conditions and features of the political environment as constant, even though in a long-term

dynamic model they will changemostly as a consequence of the policy changes initiated

by a shock. The models could then be tested by an evaluation of how identical exogenous

shocks affect political outcomes differently in different countries, or in the same country at

different times, depending on the prevailing material conditions, social and political

environments, political institutions, organizational residues, and the degree of participation

of the major interest groups. This would lead to more insights on the role played by the

factors held constant in the analysis of shocks.

What are the key features of a predictive framework? It is clear that one cannot

analyze the impact of external shocks on economic and political outcomes just by looking at

agricultural producers or rural groups. First, distortionary and compensatory policies are not

confined to only traditional agricultural policies, but include a much wider range of rural and

non-rural policies, institutions, taxes, and expenditures. Second, because the economywide

budget constraint plays such an important role in whether or not policy changes will be

implemented and what the outcomes are, the framework must incorporate all of the key

actors who bargain over the political outcomes potentially triggered by a shock. This implies

that the analysis must include the small farmers (politically active or not), rural elites, urban

elites, urban organized workers, and the unorganized and usually politically uninvolved

urban informal sector. Third, the impact of shocks and policies on economic outcomes

should be analyzed using frameworks in which exchange rates, prices, interest rates, and

wages are endogenous. Otherwise, the impact of the shocks and polices on the incomes of

the participants in the bargaining game, and on the state’s fiscal position, cannot be

measured accurately.

Such models cannot be built on the assumption that constrained maximization of

growth is being pursued, since the empirical evidence suggests clearly that agricultural and

agrarian political outcomes have often been much more inefficient and growth-reducing

62

than would be consistent with constrained optimization with distributional objectives. Any

modeling strategy must admit the possibility of such highly inefficient outcomes.

A model composed of the features discussed above would not allow for much

prediction of specific policy outcomes. In order to achieve greater predictive capability,

constraints must be added that limit actions by individual groups and the government—and

that thus therefore restrict the range of possible policy outcomes. These include the

constraints and regularities that have been reviewed extensively in the main sections of the

paper: material conditions of rural areas and the broader economies, the striking

differentials in the power of interest groups, regularities of bargaining processes, the fiscal

position of the state at the time when shocks occur, and the political and institutional

environment of the economy at the time when shock occurs.

63

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